Everything depends (a final word on financial statements)

If there is one type of answer I hate when I ask for a professional opinion, for example from a lawyer, it’s “it depends”. I know it does, goddammit, but I don’t want to learn about the entire universe of legal options. Just tell me what I need to know.

Still, I do find it tempting to answer finance questions with “it depends”. Here’s an attempt to simplify this complex reality. In an ideal world, the financial statements of a company that’s doing great look as follows:

The Profit and Loss Statement:

  • Revenue, Gross Profit, and Net Profit are each positive and are going up over time, meaning the company is bringing in more sales, generating enough gross profit to cover its operating expenses, and is overall profitable and therefore sustainable on its own.

  • When expressed as % of revenue, the Gross Profit and the Net Profit are each at least stable over time (for example, 60% and 30% respectively, and maintaining that number from one month to another), ideally increasing (which would indicate that the company is becoming more profitable over time, rather than the opposite, which would be a worrying trend).

Balance Sheet: Total Assets are substantial; Total Liabilities are a lot smaller than Total Assets, and specifically Current Liabilities are a lot less than Current Assets (in other words: whatever your company owes is less than what it owns, and especially so in the short term).

Cash Flow Statement: Operating Cash Flow is a substantial positive number. Ideally, so is overall Cash Flow (the company is generating cash from its operating activities and is building cash, rather than burning through it, on the whole).

Of course, all these things are somewhat related. If you sell profitable products or services in large enough quantities and manage to keep your operating costs reasonable, your cash balance should increase over time, and so on. But because there are many situations in which some numbers look great while others point to a serious problem, it’s always good to look at all these things together.

If the picture painted by your financial statements is less rosy than this, it’s time to dig deeper to understand the root cause. In such a case, the only advice I can offer at this time is “it depends”. Ugh, how I hate to do that.

Love and cash flow,

Jana

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