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Face Your Financials

July 1 starts the new fiscal year at many organizations and that’s a good time to think about financial management and fiscal health. There may be both an accountant and a bookkeeper on the payroll but you, the business owner, nevertheless bear the ultimate responsibility for maintaining the financial integrity of the enterprise.

Every owner must be able to make sense of basic financial data. Each financial statement has a story to tell and the business benefits greatly when the owner is able to analyze and apply the information that the numbers convey.

Three financial documents are typically generated monthly (and also compiled quarterly and annually): the Balance Sheet, the Cash Flow Statement and the Profit & Loss (or Income) Statement.

  • The Balance Sheet resembles your checking account monthly statement. This document details business assets and liabilities, showing the monetary value of all the business owns and what it owes: net worth.
  • The Cash Flow Statement is the business budget and shows what sales revenues will flow into the business and what expenses will flow out. This document shows how much money is available to cover expenses, like payroll and rent. Accounts payable (the bills) and accounts receivable (sales revenues) are listed on this statement. If you’ve ever managed a household budget, then you can master the Cash Flow Statement.
  • The Profit & Loss (Income) Statement is similar to the Cash Flow Statement. It contains many items that are also found on the IRS tax form Schedule C, Profit or Loss From a Business. Sales revenues and expenses are listed on this statement, including labor, taxes, inventory and the wholesale costs of products sold. Net Profit is shown on the last line of this statement (the bottom line).

One does not need a degree in accounting or an MBA in finance to identify which numbers on financial statements are most critical to your business. Monitoring a handful of key values, including values called ratios, will do wonders for your comfort level with financial analysis and in the process, guide your business decisions in many ways.

  • Gross Profit in the P & L indicates how much money remains after product acquisition or production costs (the wholesale cost of goods sold) have been tallied and the wholesale value of product inventory is subtracted. Providers of intangible services calculate this figure as time. How many hours were spent to develop a new service that you will offer (e.g., a workshop or webinar)? Make a reasonable estimate of the wholesale cost of your labor. Can you produce and deliver services more efficiently, or acquire products less expensively? Lower production costs increase gross profit.
  • Net Profit at the bottom line of the P & L tells the ultimate story. Every line item that precedes it, impacts it. If you want to increase that number (and don’t we all?), examine expenses and production costs to see what can be trimmed. Consider also how to increase the top line, gross sales, by generating new business.
  • Gross sales revenues in the P & L may be tracked in two ways, looking back over what occurred in previous months or years (historical comparison) and going forward (projections, or forecasting), to predict what you can reasonably expect to sell in a given period, guided by current demand. Are you achieving, exceeding, or failing your sales goals?

Finally, see your Balance Sheet and calculate these ratios, to continue the financial analysis. After your review, consider what might be done differently to either capitalize on upward trends or minimize negative impact.

  • Quick Ratio = Accounts Receivable + Cash – Inventory divided by Accounts Payable This figure indicates how much money is available to pay bills. A 2:1 ratio represents a business in good shape. However, a big receivables number can mask clients who take longer than 30 days to pay, thus signaling the owner to step up collection efforts.
  • Current Ratio = Assets divided by Liabilities This figure measures resources available to pay debts over the next 12 months. A value > 1.0 shows a business in good shape, > 2.0 is a business in excellent shape.
  • Working Capital = Current Assets – Current Liabilities Think of this number as the amount of money available to not only pay bills, but also to invest in business upgrades and expansion.
  • Debt to Equity Ratio = Total Assets divided by Total Liabilities This figure indicates how much debt the business carries relative to its assets. A value <0.5 is excellent and values > 0.5 mean the business is carrying rather heavy debt and is considered highly leveraged.

Thanks for reading,