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Using Financial Statements for Better Credit Decisions

Profit Mastery®

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Colin King, CPA, CFA

www.profitmastery.net

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Colin King, CPA, CFA

  • Professional background: accountant, investor, entrepreneur
  • Own and operate multiple businesses
  • Took PM in 2020, bought PM in 2023
  • Using these tools daily

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About Profit Mastery

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Comprehensive financial education for business owners since 1983.

1983

Founded

1M+

Alumni

40+

Years

How We Help:

Financial Training • Community • Accounting

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My Story

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My first business

In 2018, we bought our first company (parts delivery)

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Operated from midnight to 10am, five days a week

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Knew everything about analyzing financials, but no idea how to run them

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The business turned out to be…

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A complete disaster

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Why?

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My first business

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Daily ops challenges

Daily people challenges

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Adding to the problems…

Which of these is easiest to understand?

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Numbers are HARD to understand� +� Most owners are NOT accountants

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What’s the point here?

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Every business needs a �Financial Operating System

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What is a “Financial Operating System”

System: a set of principles or procedures according to which something is done; an organized framework or method.�

FOS: An “organized framework” strictly for the financial side of your business

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When to look�(CADENCE)

What to do�(ACTIONS)

What to look at�(TOOLS)

Profit Zone

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Agenda

Our goals for today:

  1. How to read financials (no really)
  2. The “Financial Review” (core tool #1)
  3. What to look for when reviewing the numbers

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The Profit Mastery System

  1. Plan properly
  2. Monitor financial position
  3. Cost structure (price, volume, cost)
  4. Manage cash flow
  5. Manage growth
  6. Capital management
  7. Plan for transition

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How a Business Works

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Why do you need this?

“If you don’t understand the accounting, you don’t understand the business.” � — Charlie Munger

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How to Read Financial Statements

The Financial Operating Cycle

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Assets = Liabilities + Net Worth

Revenue�

Net Profit

Uses of Net Profit:

  1. Pay for new assets
  2. Pay off debt
  3. Pay out to owners

Efficiency

Balance Sheet

Income Statement

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Financial Operating Cycle Takeaways

  1. Buy stuff (assets) on balance sheet
  2. Pay for it with liabilities (bank, suppliers) or equity (profits, owner money)
  3. Use stuff (assets) to grow revenue (income statement)
  4. Convert revenue into profit (income statement)
  5. Use profit to buy more stuff (A), repay liabilities (L), or take distributions (E)
  6. Measure efficiency of steps #1-5 and repeat

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Reviewing The Numbers

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The “Financial Review”

Situation: It’s the end of the month and financials are ready; what should you do next?

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Solution: This is the financial review process → basic steps/checklist for reviewing the numbers to identify actions to take. What to look at, what to look for, what to do about it.

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What to do?

“All I want to know is where I’m going to die…

…so I’ll never go there.”

– Charlie Munger

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3 Step Process

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Ratio

Your ratios tell the overall health of your business

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  1. Staying power
  2. Earnings power
  3. Efficiency

Prep

A clean view of the numbers�(mise en place)

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  1. Condense financials
  2. Multiple periods
  3. Common-size

Trend

Your trends tell the story of your business

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  1. Horizontal (across time)
  2. Vertical (within period)

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Step #1 → Prep

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Step #1 – Prep Your Financials

We need a clean view of the numbers before starting:

  1. Condensed financial statements
  2. Multiple time periods
  3. Common-size

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Prep → Trends → Ratios

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Condense = easy to read

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Take this…

And turn into this…

From dozens of accounts down to 7-10

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Easy to read, easy to spot trends, more reliable data

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Format and common-size

Always review multiple time periods �(year, quarter, month, etc.)

Common-sized P&L = divide by same period revenue

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$130

$1,440

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Step #2 → Trends

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Looking at trends

There are 2 ways to look at trends in numbers…

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  1. Horizontal (left-to-right) → Allows us to compare dollar trends, margin (%) trends, and growth rates over time (direction of business)�
  2. Vertical (up-down) → Allows us to compare different time periods (i.e. 2019 vs. 2025) or different company sizes ($1 million revenue vs. $10 million revenue)

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Horizontal & Vertical

Horizontal = left-to-right

Vertical = common-sized P&L

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Horizontal & Vertical

Horizontal = left-to-right

Vertical = common-sized P&L

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What Should We Look For?

Consider this a trend analysis “starter kit”

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  1. Growth rates for revenue, expenses, profit (direction of business)
  2. Margin trends over time (profitability direction)
  3. Fixed cost trends (operating leverage)
  4. Other key metrics

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Let’s try it…

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Income Statement

Identify direction of revenue (growing, declining, or stable)

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Income Statement

Identify direction of revenue (growing, declining, or stable)

Identify direction of EBITDA and net profit

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Income Statement

Identify direction of revenue (growing, declining, or stable)

Identify direction of EBITDA and net profit

Which costs took biggest bite out of profitability?

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Income Statement

Identify direction of revenue (growing, declining, or stable)

Identify direction of EBITDA and net profit

Which costs took biggest bite out of profitability?

Common-sizing = different view

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Where’s the leak?

Do we have a fixed cost problem or a variable cost problem here?

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Year 1

Year 2

Year 3

Sales

$1,520,000

$1,670,000

$2,160,000

Fixed Costs

$1,054,000

$1,130,000

$1,375,000

%

69.3%

67.7%

63.7%

Variable Costs

$263,800

$304,200

$450,400

%

17.4%

18.2%

20.9%

Leaks are always identifiable!

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3.5%

(x) $2.2m

= $76,000

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Balance Sheet

Cash flow problems?

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Balance Sheet

Cash flow problems?

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Where did it go?

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Balance Sheet

Borrowed money to pay for assets

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Balance Sheet

Borrowed money to pay for assets

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Funded growth through suppliers

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Balance Sheet

Borrowed money to pay for assets

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Funded growth through suppliers

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Reinvested some profits, but smaller amounts

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No dividends 😔

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Step #3 → Scorecard

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Step #3 – Ratio Scorecard

Problem: Effectively reading financials

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Solution: Convert your financials into a single page with only the most important information for your business and your financial situation.

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Ratio Scorecard = One-page document with key ratios for your business.

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What is a Ratio?

Ratio = Relationship

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Linking the financial statements

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Example:

  • Profit (from P&L)
  • Revenue (from P&L)
  • Profit ÷ Revenue = Profit Margin

Ways we can use this:

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  1. Trends → 20% margins this year are better than 18% margins last year
  2. Absolute → 45% gross margins
  3. Peers → we have the same revenue, my labor runs 45% while yours is 40%

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Ratios measure different areas of a business

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Steps

How do we build a ratio scorecard?

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  1. Gather financial information (P&L, Balance Sheet, Cash Flow)
  2. Pick metrics relevant to business model & situation
  3. Calculate ratios and add to scorecard
  4. Analyze & operating plan
  5. Update monthly

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Our Ratio Scorecard

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Anchor your scorecard with overall financial performance at the top…

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Gives us a high level view of TRENDS (sales, gross profit, net profit) over several years.

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Trend = increasing

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Our Ratio Scorecard

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Growth trends are next:

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  1. Is revenue growing, stable, declining?
  2. Are earnings growing faster or slower?

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Our Ratio Scorecard

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A complete picture of margins covering different parts of the business:

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  1. Gross profit (at sale level)
  2. Net profit (overall business)

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Our Ratio Scorecard

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Staying power metrics track our total debt & ability to pay

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  1. Leverage = how long it would take to repay all debt
  2. DSCR = profits vs. loan payment

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Our Ratio Scorecard

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Efficiency ratios measuring the entire business, marketing spend, and people:

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  1. Asset turnover (sales / assets)
  2. Marketing efficiency
  3. Labor margin (productivity)

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A Completed Scorecard

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Fine Tuning…

Add charts and visuals to spot trends easier (pictures > numbers)

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Smoothing results

If results are lumpy or seasonal, then try “rolling” metrics

  1. Rolling = 12-months
  2. Monthly = single month

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Recap

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Key Takeaways

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Financial Operating Cycle – flow of money in your business

Prep Financials – condense & common-size the data

Review Trends – lagging view of business trends & performance

Ratio Scorecard – key metrics to measure financial health & trends

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Questions?

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