You don’t have to possess a high degree of financial expertise to manage a small business. But there are three critical areas you need to monitor:
The first aspect of business operations to examine is input efficiency. This is commonly measured by knowing how much cost you incur for everything you sell. It goes beyond calculating overall gross profit by deducting from sales revenue the direct costs to manufacture or acquire goods. The truly useful figures are gross profit for each product. Studying cost fluctuations for every one of your products permits you to know the cost to produce more of anything and recognize when to adjust your prices.
For a wholesale or retail business, the costs are more than just the outlays for each item. You have to allocate expenditures for warehousing, packaging and shipping as well as personnel costs for selling, receiving and customer relations. Facility operating costs are not necessarily equally proportioned among all products. Some items require more overhead.
This same input analysis applies to service businesses, where owners can measure the costs for each type of service offered. There are always subtle variances. The nature of some projects requires more selling time. A month of emails and phone calls to land big deals is more costly than just three days to procure simpler contracts. After adding travel expenses and some contract labor, sometimes the larger projects don’t provide any more profit than the smaller ones.
The second area to assess is output efficiency. For companies providing services, the recommended measurement is revenue per employee. A growing business naturally tends to add staff. Eventually, extra support personnel are supposed to help the frontline employees produce more revenue. Constant examination of revenue per employee is a simple way to make sure this is happening.
For product-oriented companies, management of inventory is crucial. Efficient businesses move inventory quickly. There’s nothing worse for a retail or wholesale business than having to mark down old inventory to get rid of it. Plus, holding inventory uses up capital that could be deployed for other purposes. Measuring inventory turnover requires accurate financial statements. Your accountant can help you maintain that accuracy and show you how to measure inventory turnover. A trend of slowing inventory turnover is generally a sign of trouble.
The final area to evaluate is cash-flow management. This involves calculation of the average number of days required to collect accounts receivable and the days that accounts payable are held. These measurements also require accurately rendered financial statements immediately after the end of each month.
Net income and bank balances are not reliable predictors of future cash. Aging trends for accounts receivable and accounts payable are proven indicators of financial health. A sound business doesn’t continue stretching delays for paying bills. Your accountant can help you with these cash-flow calculations that allow you to avoid a cash crisis.