Need a New Years’ resolution? – learn the language of business
With the advent of a new year comes the opportunity to critically assess the financial data underlying your business. Accounting is the “language of business” and it is critical to make sure your business adheres to sound accounting procedures otherwise the language you may hear when looking at your financial statements may sound like something from a foreign country. As a small business owner it is imperative to have sound accounting and financial management which will allow the business owner to focus more time and energy on growing the business and less time and energy worrying about whether or not the numbers are right. Following are four simple, time-honored tips every business owner should follow to improve their accounting and financial management skills and, therefore, improve business profitability.
Review financial statements on a monthly basis, at least. I know, it sounds too simple, but it is surprising how many business owners are not getting accurate, timely financial statements that tell the story about the performance of the business. Your bookkeeping software should be able to produce the three financial statements most important to running your business – the balance sheet, the income statement and the statement of cash flows. The balance sheet is simply a “snapshot in time” of the assets (cash, accounts receivable, inventory, etc.), liabilities (accounts payables, bank loans, etc.) and equity (“net worth”, or simply the difference between assets and liabilities). The income statement shows the revenues and expenses of your business and ultimately computes profit. The statement of cash flows summarizes the various cash in-flows and out-flows including cash received from customers, cash paid to the bank to payoff debt and cash paid to invest in equipment, leasehold improvements, vehicles, etc. The financial statements should tell you a story about your business.
Prepare a budget. The main purpose of a budget is to control expenses and set goals. An important by-product of the budget is to make the information on the financial statements more meaningful. How can you assess financial data if you do not know what the numbers should be? Be careful not get too precise when preparing a budget. Concentrate on reasonableness, general ideas and realistic goals. Some business owners like to prepare multiple budgets. For example, three budgets may include the “more likely than not” budget, the “pie-in-sky” budget and the “nightmare scenario” budget. Whatever your preference, having at least one reasonable and well thought-out budget is an important financial tool to help you monitor your business and achieve your financial goals.
Manage the cash flow. Cash is King! This statement will ring true in almost every business setting. It certainly should be easy for the business owner to tell how much cash is on hand at any point in time (simply look at the top of the balance sheet). However, it is more challenging to determine how much cash will be on hand in 3 months. Or, 6 months. Or, maybe even in one year. Having the ability to project your business cash flows is a dynamic tool allowing for important decision to be made about the business. Such decisions may involve changes to the account receivable collection policy (or maybe the decision to establish a collection policy), or may involve a decision on how much inventory should be purchased over the next 6 months. Giving a well-drafted and realistic cash flow projection to your banker may dramatically improve your financing capabilities. Having the ability to project cash flows shows a high level of sophistication and understanding when it comes to understanding the financial inner-workings of the business.
Determine key performance indicators. Each business will have certain performance indicators that should be calculated and monitored. Some indicators such as an “accounts receivable turnover ratio” or an “inventory turnover ratio” are standard calculations that should be made for any business that has them. Other indicators may be more industry-specific such as revenue-per-table for a restaurant or revenue-per-square foot for a retail establishment. Whatever the indicators are for your business the important thing is to take the time to calculate the indicator, understand what it means and then compare it to other meaningful data. This may involve comparing the indicator to prior periods to determine a trend. Or it may involve comparing the indicator to an industry benchmark to determine how your business is stacking up. Key performance indicators can take the usefulness of your financial statements to a whole new level and dramatically improve the financial management.
In summary, be proactive with your business accounting and financial management. It is rarely a wise move to ignore the numbers of the business and rely on “luck” when it comes to overall profitability and financial performance. A favorite saying of mine is “luck is when preparation meets opportunity.” Be prepared for every opportunity by knowing exactly where you business is financially. Then, you can truly say you have mastered the language of business.