Mentioning accounting and finance may be a sure way to clear a room full of members of the public. But a room of entrepreneurs? Not so much. Entrepreneurs realize the failure of small business ventures is primarily attributable to poor accounting practices or improper financial management.
Monitoring your small business’s financial statements is the only way to know how well you’re doing and where improvements are most urgently needed. So carve out a little time each month to conduct a proper financial analysis, and begin by focusing on the basics:
The income track
Revenue growth and/or stability is key to your business’s sustainability, so start with the top line on the income statement. Compare last month’s revenue to the month immediately preceding it. Then compare it to the same month the year before. While you’re at it, consider revenue per hour worked by all employees, including you. This a very informative measure of productivity.
Have you experienced a singular event, such as a particularly large sale? If it’s a one-off, treat it as a singular event. But if you want continued large sales, you’ll need to focus your marketing efforts on ensuring this happens.
Looking at concentrated income can also be informative; for instance, if a single customer provides a large portion of your revenue, it can be a problem if that customer buys less in the future.
Don’t become so focused on top-line revenue that you ignore profit margins, which validate efficiency. Net profit margin (shown as a percentage) is derived by dividing profit by total sales. While a lower number can be acceptable in the short term, prolonged negative margins are cause for alarm: either your expenses are too high or your prices, too low.
Gross profit margin is the difference between sales and the product costs divided by sales. If you resell products, you need a consistent gross margin; rising costs would necessitate a commensurate increase in prices. Know which of the things you sell are the most profitable based on gross profit margins.
The operations engine
To be efficient, a business must promptly collect accounts receivable, remit accounts payable, and resell inventory. Know how many times last month these financial figures turned over. Receivables’ turnover is the period’s sales to customers on credit divided by the period’s average accounts receivable. Payables’ turnover is the period’s expenses billed by vendors divided by the period’s average accounts payable. Inventory turnover is the period’s cost of goods sold (for inventoried items) divided by the period’s average inventory.
The important information is the frequency with which new receivables, payables, and inventory replace the old. Consistently high turnover numbers represent management efficiency; low turnovers are warning signs.
Help is available
If you don’t want to crunch the numbers yourself, accountants and bookkeepers can help by compiling the financial data needed for evaluation, assessing this data, and comparing your business to others in the industry. Once you have this valuable information, you can adjust. And succeed.