Almost 50% of Québec SMEs close their doors within five years.* Why? For Sébastien Giroux, the ability to understand a business through numbers may explain the unfortunate phenomenon.
This is the theory he develops in a fascinating webinar as part of the 20 minutes CPA series: 20 minutes CPA : « Déchiffrer un état financier » (understanding financial statements).
Sébastien Giroux, CPA, heads up his own accounting firm, Perseus Services-Conseils, the mission of which is to support SMEs and entrepreneurs in their management and accounting challenges.
Sébastien has seen more than his share of SME financial statements and has analyzed thousands. And he has talked to as many entrepreneurs.
His first observation: entrepreneurs are incredible when it comes to skills and knowledge directly related to their field of activity.
His second observation: they are afraid of numbers. Perhaps even worse: they don’t understand them very well. This in part explains the failure rate among SMEs, Sébastien believes, and his goal through this webinar is to “make people aware of the importance of knowing how to read financial statements.”
He recognizes that entrepreneurs are mainly interested in paying less in taxes. “It’s often the only question that people ask my firm: “’How much tax am I going to pay?’ I understand that it’s an important question, but entrepreneurs should be a lot more curious about their financial results.”
Essentially, entrepreneurs should watch this webinar.
A few definitions
What is a financial statement?
A financial statement is a set of numbers from the past that provides information about what’s coming. It’s a sort of score you need to be able to read to know what notes to play to make music.
For most entrepreneurs, financial statements are like Christmas: they come once a year. And yet, “depending on the sector of activity and type of business, it may be a good idea to issue financial statements more often, such as quarterly, or even monthly. This can provide a much more strategic view of the business, to see and prepare for any bumps down the road, and to better take advantage of opportunities. In other words, financial statements are as much about the future as the past.”
There are three types of financial statements, which are used in different situations:
- the notice to reader
- the review engagement
- the audit
For the vast majority of SMEs, the notice to reader is sufficient (if you don’t know what type of financial statement your accountant prepares every year, it’s most likely a notice to reader).
Financial statements generally have three parts:
- income statement
- balance sheet
- retained earnings
Let’s look at the first two.
The balance sheet
The balance sheet is a financial snapshot of your business at a moment in time. One day later or earlier, the situation may be completely different.
The balance sheet includes assets: what you own, i.e., your cash on hand, inventory, equipment, vehicles, and so on.
Then there are liabilities, which cover what the business owes: accounts payable, current portion of long-term liabilities, long-term liabilities, and so on.
Then there is capital, which is owner’s equity and net profit (or net loss if the business is in the red).
The income statement
While the balance sheet is an instant, the income statement presents what’s happening over time. It’s a bit like a record of what happened between date X and date Y, generally the beginning and the end of the fiscal year.
Normally, the income statement has three sections:
- revenue
- cost of goods sold
- operating costs
The balance sheet and the income statement offer complementary views of a business’s financial health.
To sum up: the balance sheet is a snapshot of the business’s assets, liabilities and capital at a moment in time, whereas the income statement details the flow of transactions that occurred over a given period and their impact on the financial results.
In other words, the balance sheet shows what the business owns and what it owes, whereas the income statement illustrates the business’s performance in terms of revenue and expenditures.
Do we need to emphasize the importance of this information?
Conclusion
Sébastien suggests there are three takeaways.
First, as he says over and over during the webinar, knowing how to read your financial statements is an essential skill for sound business management.
Second, use your accountant! At least once a year, an in-depth discussion with your CPA will demystify the messages your financial statements are sending.
Third, you should adopt performance indicators specific to your business (your accountant can help with this too!). You know the saying: you can’t improve what you don’t measure.
He leaves us with an important reminder: you have six months after the fiscal year to produce your income tax return, which is normally drawn from the financial statements. And if the business owes money, the interest is calculated from the second month after the end of the fiscal year.
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* Ministère de l’Industrie et du Commerce (March 2021, p1) https://collections.banq.qc.ca/ark:/52327/bs59128 In Québec, for businesses with five or more employees the year they were founded, the survival rate after five years is 54.4%.
Watch this webinar: it’s 60 minutes well spent on your journey as an entrepreneur.
This webinar is available in french only.
