For an external stakeholder, the financial statements can be seen as the most fundamental indicator of a company’s performance. Without sound financial management practices, a firm is likely to either fail, or not operate at an optimal level. Zager et al. (2012) stated that financial reporting was more often generated for external stakeholders, for tax or financing institutions, and little or no internal reporting takes place. Karadag (2015) found that only 11% of business owners or managers analyse their financial statements as part of their decision making process. This shows us that managers, owners, and leaders alike in SMEs are often not aware of the financial position of their companies and often do not use the information at hand to make informed decisions about their company. As financial management falls under the planning section of the strategic planning framework, it forms one of the supporting pillars of any business. Therefore this lack of awareness and understanding of the significance of the use of these financials may be a contributor to the poor performance results of SMEs.
A firm’s financial statements form a foundation of historical financial position and performance. These statements present successive periods of financial operations and reveal a firms level of financial performance, giving insight into how a firm may perform in the near future (Graham & Winfield, 2012; Lovemore & Brummer, 2003). Lovemore and Brummer (2003) insist that cash flow is the ‘life blood’ of any firms success. Not having a firm grip on cash management can very quickly lead to liquidity issues, which is what often shuts companies down. Liquidity is the ability to settle all short term obligations in cash. For a SME that is going through a growth period it is imperative that it monitors its liquidity. The simplest metric for this is cash flow. If a firm’s growth requires more cash outflow than inflow then it can be detrimental to its liquidity (Madrid-Guijarro, García-Pérez-de-Lema, & van Auken, 2011). In addition to liquidity there are numerous other financial ratios that can be calculated. These can be broken down into five different fields;liquidity ratios, leverage ratios, activity ratios, economy ratios and profitability ratios. These ratio fields are explained in the table below.
These ratios provide one method for monitoring a firm’s performance. By expressing a company’s financial figures in the form of a ratio, they are then able to be compared to other financial periods as well as to other companies of different sizes (Graham & Winfield, 2012).With financial statements needing to be generated for external stakeholders, there is no excuse for managers not to utilise the documents to analyse their businesses performance. However, for reasons discussed before, such as time and knowledge, this information is not always analysed. Doing so will allow them to pre-empt cash flow or possible performance issues.
“This abridged passage was first published in its full form by M. Schreiber as ‘Why South African SME engineering managers introduce business practices: The degree to which chosen business practices influence firm performance', 2016.”