Many small and mid-sized business owners believe that their accountant, or accounting software, tells them everything they need to know about their financials. Not true. Accounting tells how much profit was made. However, what a business owner really needs to know is how much profit they should have made. How is that accomplished? The answer is to consistently measure business performance. More commonly called, financial analysis, measuring business performance will open the right door for discovering why a company didn’t earn the profits it should have and provide the “big picture” data enabling a business owner to take control and make the informed business decisions that will drive the company forward.
Even if numbers aren’t a strength, a business owner will still need to understand what they mean in order to operate a business. Without this analysis an owner might very well proceed never knowing where, or even that, the company is leaking tremendous amounts of cash. Consider the following: on average, small to mid-sized companies often fail to capture between 10 to 30% of their revenues as profit. The math is simple; say a company does $1,000,000 in sales with a profit of 10 percent or $100,000. Add 15% of the sales to the profit and you have $250,000. Without making one additional sale, the company has increased its profit line 250 percent by knowing where to look for the cash leakage and then taking corrective action.
Business owners who understand these metrics have a tremendous advantage over those who do not. It’s here, however, that most small or mid-sized business owners get stuck. The perception is that financial analysis is a “foreign” language that can only be deciphered by a trained financial expert. In fact, financial analysis can be translated into easy-to-understand “English.” When this is done, any business owner can immediately identify areas in which their company is experiencing minor to serious financial distress which causes hard earned revenues to escape before reaching the bottom line profits. Demystifying the language of financial statements and not depending on others to interpret numbers is the key to taking control.
So let’s begin with a few definitions. In-depth explanations of each can be found with a little research. The most important financial statements are the balance sheet, the profit and loss income statement and the cash-flow statement.
Simply put, the balance sheet is a list of the accumulated assets and liabilities incurred by the business. The difference between the two represents the net worth of the business. The profit and loss answers the question, “How did the company do?” The cash-flow statement answers the question, “Where was the cash used?”
Understanding these statements is essential. They tell what’s happened in the past and can serve as a predictor for the future. Yet, just understanding still doesn’t tell how to interpret the numbers in the context of the overall operation and profitability. Enter the CFO who, among his/her backward and forward looking analysis is the most likely person to identify and track upward or downward trends so that an owner can take immediate corrective action when needed.
What if a company can’t afford to hire a CFO? How can owners successfully analyze their financials without mis-interpreting the data or spending excessive amounts of time?
Fortunately there are affordable business performance software packages that are written for the non-financial professional. A cautionary note however, carefully research the software before purchasing, because many promote themselves as easy-to-use, but would challenge even an MBA in finance.
Look for software that:
• Within a few hours, from start to finish, indicates specific areas where the company is losing money and where corrections need to be made.
• Encourages scheduling a demo prior to purchasing.
• Provides a built-in tutorial.
• Produces easy to read and understandable components among which are: current and optimized income statements; labor efficiency; break-even analysis; bankruptcy potential (Z-Score); ROI by line item; all major indicators and business potential.
• Is simplistic enough to use habitually so that it becomes a tool for continuous improvement.
• Does not need a financial professional to interpret the data.
No matter it is achieved, measuring a company’s performance and making operational, organizational and strategic corrections is top management’s most important responsibility.
Max Gregorich is the CEO, of CEO1Stop