Use your statements to enhance financial performance.

• Author: Shepherd, Connie
• Position: Good financial management means understanding business financial statements

Sound financial management starts with an understanding of business financial statements. Following is an overview of financial statements and how you can use them to better gauge the financial performance of your company, as well as project and plan for future financing needs.

Turbocharge your financial performance--Any business that files a corporate tax return (partnerships and C and S corporations) must create a balance sheet and income statement. Along with a cash-flow statement, these comprise the three types of business financial statements. A basic understanding of financial statements and how to interpret them is the first step to optimizing your company's financial performance.

A balance sheet is simply a snapshot of your financial position at any given point in time, reflecting what your company owns (assets) vs. what your company owes (liabilities). Current assets are the resources that can be most quickly converted into cash--things like your cash reserves, accounts receivable, inventory and short-term investments. Current liabilities are all the short-term expenses that are incurred to finance the operations of your business--accounts payable, loans, taxes, etc.

The critical ratio to derive from your balance sheet is the current ratio, which shows how many times the current debt could be paid off with current assets. It's used frequently by investors and lenders, who are generally looking for a ratio of 2 to 1 or higher in companies they're considering financing. Here's the formula: Current Assets/Current Liabilities = Current Ratio.

Debt-to-equity is another crucial balance sheet ratio, measuring your company's debt capacity, or how much debt you can handle. Lenders and investors generally want to see a ratio of 2 to 1 or less, which indicates that your company is not overextended financially. The formula: Total Debt / Shareholder's Equity = Debt-to-Equity.

The income statement (or P&L) tells you how much money you made (or lost) for a given period of time--usually a month, quarter or year. It subtracts all expenses and taxes from net sales (or revenue) to help you arrive at the proverbial bottom line, or net income.

To determine net income, first subtract your cost of goods sold, which are all of the costs incurred directly in producing your product--most commonly, direct labor and, in a manufacturing company, direct materials and overhead--to arrive at your gross profit. Next, subtract depreciation and amortization and SG&A...