Business Success and Financial Savvy
Financial knowledge is key to making your home-based business a success.

By Rayanna Anderson

Many Americans cherish a dream of business success. And many pursue their dream by starting out as a home-based business in order to keep overhead and expenses low. But, according to Business Week Magazine, five of every 10 companies fail in the first five years of business. And the leading cause of failure is lack of money. How can you avoid becoming one of the statistics, even though you may already be working with low overhead at home?

One of the key contributors to success appears to be the owner's ability to understand and use the company's financial statements. Making it in today's business world requires more than looking at the bottom line on income statements occasionally.

It involves understanding and interpreting what the income statement, balance sheet and some key financial ratios really mean. It involves using that information to make informed business decisions. So, if you're not using your financial statements in this way, how do you get started?

The Income Statement
The first step is to acquire a good knowledge of what the reports are really telling you. The income statement is your best starting point. Also called a P&L, profit and loss statement or an income and expense report, it is the summary of events that happened over a period time.

It provides a report of revenue and expenses and is required for tax purposes. The income statement tells how the business is doing and how profitable it is. Information from the income statement can be used to make better-informed decisions about your company's pricing, margin maintenance and expense control.

The income statement is good for showing you information at a point in time, but how do you know if your numbers are good or bad? One thing you can do is look at trends by comparing dollar amounts from year to year or from month to month. Another option is comparing your results with others in the same industry. Your best resource is a trade association for your business.

When that is not available, another resource is industry standard information from Robert Morris Associates, Inc., available at most libraries, University of Missouri Outreach and Extension Centers, or Small Business Development Centers (www.missouribusiness.net).

The Balance Sheet
The second critical source of information is the balance sheet. The balance sheet shows what the company owns (its assets), what the company owes (its liabilities) and the bottom line (owner equity). It gives the financial condition of the company at a point in time.

And just like the income statement, if you really want to see a true picture of how you are doing, you need to look at trends. You will also benefit from comparing your statement to companies in your same industry.

Understanding Ratios
Understanding the information on the income statement and balance sheet is only part of the equation. To truly be able to use financial information to make better business decisions, you will often need to look at numbers in relationship to each other. You can do that with ratios.

Ratios can tell you about the efficiency of your operation. The key is to choose a few important ratios to track and review in your company. Here are a few that you might consider:
current ratio, which tells you the percentage of current assets versus current liabilities (this impacts your ability to pay your bills); days receivable ratio, which tells you the average number of days customers are taking to pay you; days payable ratio, which tells you the average number of days you are taking to pay your suppliers; and inventory turnover ratio, which tells you the number of times inventory turns over in a year (this tells you how well you are managing your inventory).

Remember what the statistics tell us: success can be tied to sound financial knowledge. Begin your road to success by learning to use your financial statements as the powerful tools they are.

Rayanna Anderson is the assistant director of the Southwest Missouri State University Small Business Development Center (SBDC).