What Does Your Business Really Need?

Business Coaching: April 10, 2015

What Does Your Business Really Need?

Last month we reviewed your personal cash flow patterns and the cash flow patterns for your business.

Now, we want to take a closer look at your financial statements. Look at all three statements: Balance Sheet (Statement of Assets & Liabilities), Income Statement (Statement of Profit & Loss) and Statement of Cash Flows.

First up, let’s look at the Balance Sheet. This is a snapshot of the present. What is the total amount of your assets? What is the total amount of your liabilities?

I recommend that most businesses keep their in-house books on the accrual method, so that you can see how much you have in receivables (people owe you) and how much you have in payments (you owe other people). It’s also a predictor of what might happen with your cash. For example, if you don’t have much in cash or cash equivalents, you need to work quickly to change some of those other assets.

The next page has a sample Sole Proprietorship Balance Sheet. If you have partners or other members (LLC), you will show capital accounts. If you have a corporation, you’ll track your retained earnings.

One of the things to pay attention to here is the amount of return you are receiving on your assets. Is your inventory turning over fast enough or is it stuck? That can be a cash flow pit. How about accounts receivable? Are your customers paying you on a timely basis or are you having to chase them?

One of the easiest ways to improve your cash flow quickly to improve your payment policies. Use a credit card to collect right away or give discounts for cash. It’s expensive, time consuming and stressful to have to chase money.

Look at your current liabilities compared to long-term liabilities. Generally the plan is to push off liabilities and get cash quick.

The Balance Sheet shows your present. A Profit & Loss (Income Statement) shows your past.

When I see a P & L, I’m looking for the percentages first. What is the gross profit percentage? Gross profit is the profit after cost of goods have been subtracted. Divide that amount by the total sales. That tells you what your gross profit is. You can now use this to compare to other businesses in your industry. For example, if you have a restaurant, you want a food cost of no more than 40%, so you’ll have a gross profit of 60% or more. This process of changing your P & L into percentages is called creating a same size financial. In the future, you’ll want to track your financials both by the numbers and by the percentage.

The next ratio to look at is your net income percentage. As your business grows, you will add indirect, or general & administrative, costs. Watch that bottomline! Unfortunately, the overhead doesn’t grow in a steady line. All of a sudden, you’ll reach a plateau and your profit falls off. This is the time to watch your profit. More sales is not the answer when your business hits this benchmark.

Profit & Loss Statement:

The Profit & Loss Statement is all about comparison. How do your percentages line up? What do you need to do more of? What do you need to do less of?

The Statement of Cash Flows is all about the future. This tells you where your cash is coming from or going to. It’s about the flow of cash. And let’s face it, if you don’t have cash, your business can’t last.

But the source of the cash is just as important as the cash itself. If you have cash in the bank and it all came in the form of a loan or because you sold investments or equity, it doesn’t mean your business is making money.

The Statement of Cash Flows starts with the net income from the Profit & Loss statement and then is adjusted by items that affected income that didn’t impact cash. For example, depreciation expense is added back because that doesn’t take cash. If inventories are increased, your cash flow goes down. That’s because you had to pay for them but it isn’t an expense.

If you sell assets, you will have cash flow from investments. Likewise, if you buy assets, you will use cash flow. It doesn’t mean that it’s good or bad. It just reports what happened.

And, of course, we’ve got to talk about financing. I’m always fascinated by how many starting business owners look first, second and third for loans. Starting a business with an unproven concept? Let’s find someone to loan us money. Growing a business into a new market? Let’s find someone to loan us money. Hit a bumpy spot with the business? Let’s find someone to loan us money. If all your money is coming from loans, there is a day of reckoning coming.

What is it that your business really needs? Is it a loan? Is it more sales? Is it more profit? Reduced costs? An expansion that doesn’t break the bank? The story of your business is in your financial statement. Don’t assume you know what you need until you’ve reviewed them all.