Financials- Know how to read your scorecard like a business coach!
Aside from being a business coach, this author is an avid golfer so forgive the theme. Its April and spring is in the air, the Masters has crowned a new winner in the most exciting way and colors of spring are emerging. This month, we will be talking about your business’ scorecard. As we meet with new clients and begin engagements, one element that has surprised us is the lack of good solid financials. For an analogy, imagine playing a round of golf or any sport reaching the end of the game and being told you lost. If you are competitive, then you are greatly disappointed. You then ask “what was the score?”. Answer, ‘I don’t know but you lost.” Now how do you feel? Exactly!
For business, having a good set of business financials is critical. They let you know what your profit was and whether or not you are on track to reach your goals. Sadly, many businesses do not have a good set of financials that they use to operate their business. They operate on what we call the check book model. There is money in the checkbook so we must be doing ok. The reality is you may not be okay.
If you are a business owner, you should be able to examine and recognize a variety of issues in your business using these three key documents:
1. Income statement
2. Balance sheet
3. Cash flow statement
We have left budgeting out here as it was discussed in a previous article.
Let’s take a quick look at each of these documents and discuss how to use them.
Income statement- this document shows the various expenses for the period as well as incomes. Commonly done on a monthly basis it provides and insight into the volume of business being done and where the majority of costs are. This document is very helpful in seeing how your costs are moving and where the potential pain points might lie. As an example, material costs may be rising as a percentage of sales, or you overtime costs are creeping up due to staffing shortages. Once you recognize the issue the key is to develop plan to address it. Measuring the result is already there and can be refined if needed.
Balance sheet- a document that shows where all the money is in the business including how much owners value (equity) you have built. An easy way to remember the formula is “BEER” or ALE (Assets minus Liabilities equals Equity. From this document, you can readily see where your money is; inventory, A/R or the checkbook. Additionally, you can see what you have at risk in terms of A/P and other liabilities (loans, LOCs, etc.). The difference is the amount of money, value of the business on a cash basis. Key areas to watch for are increasing inventory levels as a percentage of sales, growing A/R or A/P due to unconscious decisions.
Cash flow statement– is typically a 13-week projection of what you think will happen in the business. It includes items like sales, collections, purchases, labor costs, insurance, etc. You can think of it as a projected on-hand of cash in your business. It can prove crucial to avoiding last minute crisis. If you are seeing significant growth or are in a seasonal business where you have bursts in net-working capital needs. Working with this tool is important. It can also give you a heads up in talking with your lender about your line of credit (LOC) level.
If you are a business leader and are not comfortable with your financial documents and are relying on your CPA or bookkeeper to handle this for you. STOP! The most disturbing thing we have seen in our consulting business is that many CPA’s do not understand manufacturing accounting and are making incorrect adjustments.
SPC Consulting will work with your team and you to understand how to properly keep good records and analyze them on a periodic basis. This work will help you sleep better and provide added leverage with your financial partner when they see your high level of financial knowledge of your business.