Is your organization as healthy as you think it is? It’s not as easy as just looking at your company’s bottom-line profit. When communicating results with investors, outside auditors and lenders, it’s human nature for a business owner or CFO to describe their company’s financial performance in the best possible light. It’s also common and understandable to use offsetting favorable events to sidestep explaining any “surprises” and avoid significant variances to plan. Even accurate financial statements that follow GAAP can mask underlying operating issues.
But, this ostrich syndrome — sticking your head in the sand to avoid uncomfortable facts — is dangerous for your business. Failure to diagnose and respond to underlying issues can lead to eroding profits, loss of key employees, loan covenant violations, or tumbling enterprise valuations, forcing seemingly high-performing enterprises to downsize and restructure.
Understanding your true financial performance
It's imperative that finance executives and management understand the reality of their performance when analyzing financial results internally — in other words, adjusting for infrequent transactions, whether they be good or bad. For example, an income statement can be strategically “smoothed out” by using one-time favorable items to offset poor performance in another area. It’s also common for companies to time the reversal of unnecessary reserves during the same period they suffer from an unrelated expenditure or loss of revenues — hiding the unrelated bit of bad news to outsiders if not separately disclosed. All the while, the root issues that will negatively affect future financial performance are not addressed. How do you understand the true financial health of your business when accounting corrections or unusual entries distort the results?
How do you understand the true financial health of your business when accounting corrections or unusual entries distort the results?
- Produce normalized financial statements — One effective method to monitor the tangible results is to produce “normalized” financial statements. A normalized presentation seeks to eliminate one-time events, both good and bad, to produce a report card of how your business is operating. However, eliminating these one-time events is just part of the analysis. You should evaluate whether these events are truly nonrecurring and justify the “normalized” results with improved outcomes overtime.
- Implement a 12-month rolling financial forecast — Another alternative technique is to implement a 12-month rolling financial forecast to identify performance drivers and make better business decisions in real-time. Using the latest historical metrics, intended business strategies, and predicted changes to assumptions, you can produce a robust model for expected results to measure and evaluate future operations.
To maintain positive financial health, remain resilient, and drive success, you can review the recent past through normalized financial statements, or look to the future via realistic rolling financial forecast projections. Keep your head out of the sand, and don't neglect any underlying problems because you "made your numbers."