Corporate Finance & Planning Insights for Multi-Generational Family Businesses
This post is the first of four installments from our Basics of Financial Statement Analysis whitepaper. In this series of posts, our goal is to help readers develop an understanding of the basic contours of the three principal financial statements. The balance sheet, income statement, and statement of cash flows are each indispensable components of the “story” that the financial statements tell about a company. This week, we focus on the balance sheet.
In our last post in this series, we focused on operating income, which is a critical measure for evaluating the performance of management since it is unaffected by financing and tax decisions made by the board of directors. Net income, on the other hand, reveals how those board-level decisions influence your family business’s earnings and ability to pay dividends. Everyone likes to talk about EBITDA and EBIT – and those are important metrics – but only net income measures the increase in the family’s wealth from owning the business.
When engaging in shop talk about a client project, our colleagues inevitably start by asking, “What business is the client in?” In nearly all cases, the appropriate response to the question is a brief description of the client’s industry. But for a small minority of clients whose financial performance is truly extraordinary, the correct response is that they are in the “money making” business. For these clients, the particular “it” of what they do is secondary to the fact that they make a lot of money doing it. Has your family business joined the exclusive club whose members are in the “money making” business?
It may be a tiresome cliché, but your family business really does make money buying low and selling high. It’s important to think about gross margin, because it tells you how much of a “mark-up” your customers are willing to pay for your good or service. The higher the “mark-up” the more revenue will be available to cover operating expenses and generate an operating profit.
The income statement is a natural place to begin analyzing a company’s financial results, and revenue is the natural starting point for that analysis. We recently heard someone remark that everything good in business starts with revenue, and our experience working with family businesses of all stripes confirms that sentiment. While the absolute amount of revenue can be instructive (i.e., are we looking at a $10 million business or a $100 million business?), it is the trend in revenue that is most revealing. Is the business growing, treading water, or shrinking?
Reading financial statements well is all about asking the right questions. In this series of posts, our goal is to help family business directors ask the right questions of their financial statements. Asking better questions leads to better financial and business decisions.
Stewarding a multi-generation family business is a privilege that comes with certain responsibilities, and each family business faces a unique set of challenges at any given time. For some, shareholder engagement is not currently an issue, but establishing a workable management accountability program is. For others, dividend policy is easy, while next gen development weighs heavily. Through our family business advisory services practice, we work with successful families facing issues like these every day.
This is the inaugural post for our Family Business Director blog. By way of introduction, we thought we would anticipate a few questions that you might have.
