Start year with a commitment to financial management
A new year offers a new opportunity to critically assess the financial data underlying your business. As the national and local economies work through the economic recovery, it’s critical to stay on top of your business finances. As a small business owner, it’s imperative to have sound accounting and financial management that allows you to focus more time and energy on growing your business and less time and energy worrying whether or not the numbers are right.
Here are four simple, time-honored tips every business owner should follow to improve their accounting and financial management skills and, therefore, profitability.
Review financial statements on a monthly basis, at least. I know, it sounds too simple. But it’s surprising how many business owners don’t get accurate, timely financial statements about the performance of their businesses. Your bookkeeping software should be able to produce the three financial statements most important to running your business: the balance sheet, income statement and statement of cash flows.
A balance sheet offers 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). An income statement shows the revenues and expenses of the business and, ultimately, computes profit. The statement of cash flows summarizes various cash in-flows and out-flows, including cash received from customers, cash paid to the bank to pay off debt and cash paid to invest in such things as equipment, leasehold improvements and vehicles.
Financial statements should tell you a story about your business. What are you spending money on? Are you satisfied with the detail? Too little? Too much? It’s your business and your financial statements, and they should tell you what you want and need to know.
Prepare a budget. The main purpose of a budget is to control expenses and set goals. An important byproduct of a budget is to make the information on the financial statements more meaningful. How can you assess financial data if you don’t 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. Three budgets might include the “more-likely-than-not” budget, “pie-in-the-sky” budget and “nightmare scenario” budget. Whatever your preference, having at least one reasonable and well thought-out budget constitutes an important financial tool to help you monitor your business and achieve your financial goals.
Manage cash flow. Cash is king. This statement will ring true in almost every business setting. It certainly should be easy for a business owner to tell how much cash is on hand at any point in time — simply look at the top of the balance sheet. It’s more challenging, though, to determine how much cash will be on hand in three months, six months or maybe even in a year.
Projecting your business cash flows is a dynamic tool allowing for important decisions to be made about the business. Such decisions could involve changes to the accounts receivable collection policy — or the decision to establish a collection policy — as well as how much inventory should be purchased over the next six months. Giving a well-drafted and realistic cash flow projection to your banker also could dramatically improve your financing capabilities.
Don’t leave it up to the “hope and pray” method of projecting cash flows. The ability to project cash flows shows a high level of sophistication and understanding when it comes to the financial inner workings of the business.
Determine key performance indicators. Each business will have certain performance indicators that should be calculated and monitored. Such indicators as an accounts receivable turnover ratio or inventory turnover ratio are standard calculations that should be made for any business that has customer accounts receivable and inventory. Other indicators might be more industry specific — 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 could involve comparing the indicator to prior periods to determine a trend or comparing the indicator to an industry benchmark to determine how your business stacks up against similar businesses in your industry. Key performance indicators can take the usefulness of your financial statements to a whole new level and dramatically improve the financial management of your business.
Be proactive with your business accounting and financial management. It’s rarely a wise move to ignore the numbers and rely on luck when it comes to profitability. A favorite saying of mine is “luck is when preparation meets opportunity.” Be prepared for every opportunity by knowing exactly where your business is financially.