The Best Read: Reading Your Financials!
For many people the most boring aspect of running a business is reading their financials. For some it is so onerous they try to avoid the experience every month and only want to know the bottom number - profit or loss! However, your P/L, Balance Sheet and Cash Flow statements are the cardiogram of your business. To maintain our personal good health we get physicals on a regular basis and for many that means a cardiogram and even a stress test to make sure all pumps and valves are working properly. For good health and longevity we would not go without one.
Your financial statements, on a monthly basis (minimum), are the cardiogram of your company. Properly designed financial statements provide insight on how the key elements of your company are performing. While significant focus is put on how much profit (hopefully) you made. Profit will take care of itself if the key profit performance factors of your business are under control.
Financial ratios help you quickly get the feel of where the pain might be if profit is less than expected. The value for each ratio may be measured against historical averages or market benchmarks. Obviously performance factors that have current values on the wrong side of the desired value deserve your first attention. There is always a story behind each number so it is necessary to uncover the facts that influenced the outcome in order to take effective action. It is in this process that you can learn a lot about your company.
- Are unusual numbers the result of data collected incorrectly (wrong coding)?
- Is it a one-time anomaly which will correct itself in successive periods(3 versus 2 payroll periods)?
- Were all of the closing cutoffs made on time so that all revenue and all expenses for the period are included?
- Is your Cost of Goods sold - material, labor, contracted services - consistent for the revenue recorded?
- Are you absorbing too much labor that is nonproductive?
- Are you buying from the best price/quality/delivery source?
- Is there a mix shift in the products delivered that resulted in less margin than what was expected?
- Are your overhead expenses inline?
- Salaries are often fixed for the period but variable expenses such as marketing, expense accounts, travel, entertainment, etc. may get out of line.
- Are your commission payments consistent with revenue and discounts?
- Does your balance sheet show any surprises?
- Is your inventory level consistent with the production demand?
- Are customer deposits collected and in reserve for the product or service ordered and not consumed by other operations?
- Is debt service under control and do you have adequate operating reserves in the event of an unexpected change in business?
- How healthy is your cash-flow?
- Do you have sufficient cash to ride out the normal flow of high expenses and valleys of revenue?
- Do you have the cash to afford the capital improvements that you are planning?
- Using a conservative revenue forecast how strong is your cash position two to three months out?
These are just a few of the questions that need to be considered as you examine your financial feedback on your business. In too many cases I have observed owners/CEO's taking a complacent attitude toward their basic financial reports "since they were profitable." However, when an unprofitable period arrived they then had plenty of time to dive into the details only to find out that the "unprofitable" signals began several periods earlier. Timely action would have avoided the profit problem or reduced it significantly through proactive measures instead of reactively applying CPR to the business.
Experienced owners/CEO's take advantage of interim metrics that track key performance factors that influence their financials so that on a daily/weekly basis they get snapshots of what is going on without waiting until the next month to discover a problem. This serves as a pace maker to make sure that the pulse of the business is appropriate and if not - inject their attention and leadership to get things back on track.
Read your financials and develop a good feel for how your business operates so that you can enjoy good business health!