Accounting for the Numberphobic: A Survival Guide for Small Business Owners
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Audiobook:
By: Dawn Fotopulos
Rating: A
“If you want to be successful at managing a business, you need to become proficient at handling certain numbers. Put simply, you need to be able to read and understand your financial dashboard.”
Your Financial Dashboard: The Net Income Statement, Cash Flow Statement, and Balance Sheet
Your bookkeeper isn’t going to make decisions for you. He’s there to make sure you have accurate and timely records of business transactions to send to your CPA. Your CPA is not going to make decisions either. He is there to prepare your taxes and make sure you don’t get audited. You are the one in the driver’s seat.
If you want to be a successful businessman or woman, you need to understand your business. If you want to understand your business, you MUST be able to understand basic financial statements.
Net Income Statement
Your Net Income Statement is like the speedometer in your car. It’s the gauge you’re going to want to check frequently - at least every 30 days - to make sure you’re maintaining healthy momentum.
The Net Income Statement will reveal whether your business is generating a profit, breaking even, or losing money. If the number on the bottom line (Net Income) is positive, you’re making money. If it’s zero, you’re breaking even. If it’s negative, you’re losing money.
Net Income Statement
Net Revenue
$4,500 (100%)
Cost of Goods Sold
($3,500) (78%)
Total Gross Margin
$1,000 (22%)
Fixed Expenses
Rent
$1,500 (33%)
Variable Expenses
Marketing
$1,000
Utilities
$150
Insurance
$150
Total Variable Expenses
$1,300 (28%)
Total Operating Expenses
$2,800
Earnings Before Taxes
($1,800)
Taxes
$0
Net Income
($1,800)
The goal is to show consistent profitability on a quarterly basis. The business can tolerate a lean month, but the goal is to adjust course and show a profit by the end of the quarter. If not, the business is heading for trouble.
Management Advice:
Cost of Goods Sold (COGS): The total cost of the direct materials and direct labor used in the production of your products. The rule of thumb is to sell a product at COGS plus 45 percent, to make it worth the risk to offer that product. I.e. Keep the COGS to be 70 percent of net revenue or lower.
Gross Margin: You don’t run your business on revenue - you run it on gross margin, which is the gross profit available to pay all your operating expenses. This is what is left after you deduct COGS. The rule of thumb is to keep gross margin greater than 30 percent of net revenue.
Operating Expenses: Rent, insurance, salaries, other general and admin, professional fees (accountants and lawyers), and taxes. Do not take on fixed expenses that require the business to scramble to generate more sales to pay for them. Grow sales faster than fixed expenses. A rule of thumb is to keep the fixed portion of these expenses at 20% or less of net revenue and the variable portion at 20% or less of net revenue as well.
Service Businesses:
The cost of sales in businesses that provide services is the value of time and expertise. Clients are paying for the years of experience not the hours on the job.
It is critically important to track the number of person-hours invested in projects so there is a correlation between what is being charged and how much it costs in time to deliver the final product.
Cash Flow Statement
Your gas gauge. Cash is to your business as gasoline is to your car.
This measures the inflows and outflows of cash from operations. From this statement, you’ll know whether the business can pay its expenses next month or next quarter. This statement will also reveal how long the business can be sustained without additional sources of cash. Think of this like the check register for a personal bank account. It measures Beginning Cash, Cash In (payments from customers), Cash Out (expenses paid), and Ending Cash.
Cash Flow Statement - February
Starting Cash
$6,000
Cash In
$0
Cash Out
$5,000
Ending Cash
$1,000
Cash is to your business as blood is to your body. The definition of bankruptcy is running out of cash - not net revenue, not profits, but cash. Managing cash is mission critical to keeping a business alive.
Managing Your Cash Flow
Cash Cycle:
A sale is made.
The goods are shipped or the services are rendered.
As soon as the business has delivered, an invoice goes out with payment terms clearly stated.
Once the invoice is paid, the cash is deposited in the business’s account.
Operating expenses can now be paid.
Every step of this cycle MUST be managed.
Myth:If the business delivers the final product for the customer, then the customer knows how much is owed on the project and will pay the bill promptly.
Truth: Only an invoice triggers the payment cycle. Deliver the invoice the same day!
Balance Sheet
The oil pressure gauge on your financial dashboard.
This captures the full results of business operations since the beginning. It is a snapshot of the health of the business at a moment in time. Assets (what is owned by the business) minus liabilities (what is owed by the business) reveals the owner's equity (the net worth of the company).
Assets - Liabilities = Owner’s Equity
Balance Sheet
Assets
Liabilities
Current Assets
Accounts Receivable
Current Liabilities
Accounts Payable
Notes Payable
Fixed Assets
Long-Term Liabilities
Mortgage
Total Assets
Total Liabilities
Owner’s Equity
How to Improve Your Balance Sheet
Raise your gross margin to 30% or greater.
Invoice on a timely basis and manage the collections process.
Keep all expenses as low as possible for as long as possible.
Inventory Management (Apartment Industry…Think Made Ready Product)
If inventory is much higher than demand for the product, too much cash went into manufacturing it and the sales are not there to convert it into net revenue and then back into cash. This is considered a demand problem.
What are the most important things to remember about inventory management?
Test the market with samples first, if you can, to know what is really going to sell.
If possible, don’t build inventory in large quantities and eat up cash unless the business has the orders in hand.
Try to find strategic partners that have quick turn-arounds for building inventory.
Err on the side of less rather than more inventory as a rule of thumb.
Conclusion
If you want to be a successful business person, you need to understand your basic financial statements and what they are telling you about your business. Take time to get educated on this from your Bookkeeper and CPA.
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