Advantages & Disadvantages of Financial Statement Analysis in Decision Making
Business decision making is both art and science. A business owner must pay close attention to numerical information included on income statements and balance sheets to understand what is working, and to avoid spending money he doesn't have -- but financial statements are tools, not crystal balls. Successful business planning involves balancing a range of variables and options, relying on experience and subjective judgments as well as firm numbers.
The numbers on financial statements provide clear, objective information about a company's situation, including how much it earns and how much it owes. This clarity and quantifiable assessment is valuable for making financial decisions such as when to cut costs and when to invest in expansion, but not all business decisions can be made on the basis of objective financial criteria alone. Your business may choose to also consider intangible variables, such as quality of life issues affecting employees and owners.
Numbers on financial statements can provide a business owner with a false sense of security, limiting proactive business development. For example, a company's financial statement may show that it is earning a profit and saving enough money to improve its bottom line. It looks good on paper, but these sales and profit figures may depend on an unsustainable business model, such as selling off inventory that cannot be easily replaced. Business decisions should be based on real-time observations of business activities in addition to financial statement information.
Financial statements include information that is directly related to your company's financial health and its capacity to undertake new ventures. The amount of money you have in the bank and your track record of earnings are directly relevant to business decisions, but plenty of other relevant information does not make its way onto your financial statements, and this information can also be critical to business decisions. For example, financial statements will not tell you whether a recent trend has broad-based popular appeal. Information about this appeal may directly impact whether a particular type of product development is a sound business decision.
Although it's important to base business decisions on sound numbers such as cash flow and company earnings, business development also relies on intuition and timing. Savvy and successful entrepreneurs know how to trust their gut instincts, even when a strict analysis of financial statements may suggest that a business decision is inadvisable. For example, the owner of a shoe store may anticipate that a particular type of shoe will sell particularly well. If the owner has successfully recognized profitable trends in the past, then investing in sufficient inventory levels of that shoe could be a smart strategic move, even if the balance sheet argues against it.