by Dawn Fotopulos
According to an Intuit survey from 2015, 87% of small business owners do their own books and 47% claim financial illiteracy. It’s not a surprise that more than half of small business start-ups never survive to see year 5 of operations; it’s remarkable that half do. If you follow start-up history out to year eight, the failure rates are in the 80+ percentage. Any thinking person would take their start-up capital and go to Las Vegas. You’d have much better odds of winning there.
What if, by learning just a few key ideas, you could double even triple your probability of small business survival? What if a one day commitment of your time could change the next twenty years of your future and the future of your household? What if what’s in this article prevents your small business from becoming a statistic? It can. Here’s how.
Every business owner needs to answer three key questions:
- Am I making money? (Showing a profit)
- Do I have enough money to pay the bills? (Enough cash flow)
- Am I building wealth or destroying it? (Building net worth)
Your Financial Dashboard
It doesn’t matter if you’re in a service business or selling products for a living, you MUST be able to answer these questions weekly. You find the answers to these questions by being able to read your financial dashboard. An accounting professional can create this dashboard; you just need to understand what each gauge is revealing.
You have a dashboard in your car for a reason; each indicator tells you something about how the car is running. Your speedometer tells you how fast you’re going. In a business, your Net Income Statement will show you how fast your business is generating profits.
Your gas tank measures how much fuel you have left and if you need to buy more before running out. In a business, your Cash Flow Statement shows you how much cash you have available to pay bills. This is different than your bank statement balance. You might owe a lot of suppliers money and your bank statement will not capture that.
You oil pressure gauge tells you if there’s enough pressure for combustion to turn the engine over, but not so much that you blow a gasket! This is the metaphor I use when talking about your business Balance Sheet. This is the statement that shows your assets or what you own versus your liabilities (what you owe) and if the difference is positive or negative. You want assets to grow faster than liabilities. That’s how you grow Net Worth. Here’s the deal…
You don’t have to be an engine designer to drive a car, but you have to understand some basics to drive it safely to your destination. You would never drive with your eyes closed, so let’s open our eyes when we’re running our businesses too.
The Net Income Statement is like a great, big pile of cash that gets smaller and smaller as you acknowledge the bills you have to pay. The top line is your revenue line or sales line. Every time you ring the cash register, this line gets bigger. Don’t get too excited yet because you could be growing your revenues and still lose money! You don’t want more revenues; you want more profitable revenues.
If you’re selling products you need to pay your suppliers for direct costs, that is, costs directly associated with creating a finished product like fabric, hang tags etc. That’s Cost of Goods Sold or COGS. Take COGS away from Net Revenues and you get a VERY important number; that is Gross Margin or Gross Profit (same thing). You run your business on Gross Margin NOT on revenues. It is from Gross Margin that you get to pay all your bills. The higher your Gross Margin the greater the likelihood your business will thrive.
From Gross Margin you pay all your fixed and variable expenses, and taxes. What’s leftover is Net Income. This number is why you’re in business. Accounting for the Numberphobic will give you at least five key ways you can review your Gross Margin and improve it.
Here are two rules of thumb: if your Gross Margin is not at least 30% of revenues and your Net Income is not at least 15% of Revenues, your business is headed from rough seas.
The Cash Flow Statement is like a leaky bucket.
We care about our cash position at all times because revenues don’t always translate into cash. Sometimes customers are late paying us, they take discounts or they never pay us at all. We have to monitor our cash position because cash is to our business like blood is to our body. If we run out of cash, we can no longer operate and we go bankrupt. According to JP Morgan Institute, 75% of small businesses have 30days or less cash on hand. A rule of thumb is that you want at least 3 months cash on hand to keep your business moving in the right direction. Accounting for the Numberphobic has many very easy ways you can improve cash flow almost overnight.
The Balance Sheet is like a microscope. Every banker and investor in the world will scrutinize your Balance Sheet see if assets are growing faster than liabilities, which is what you want too.
Assets minus liabilities tells you were your Net Worth is. Taking out a loan is the easy part, using those resources wisely to get a return, then paying back the loan; this is the hard part. A rule of thumb here is to match the length of the loan to the asset you’re financing. Short term loans or credit lines are great for managing inventory levels, making purchases from suppliers and bridging slow sales periods. Long term loans are appropriate for purchasing land or buildings. If you have to borrow money every month to pay your staff, the business isn’t generating enough profit and cash flow to support itself. That’s a red flag and pay attention to it.
Material by Dawn Fotopulos, DFConsulting, Inc. All rights reserved. Posted on The BAM Review blog with kind permission of author.
Accounting for the Numberphobic: A Survival Guide for Small Business Owners won Best Business Book in Economics in 2015 from Small Business Trends because the content in the book is changing lives. This little book is on a big mission; to double survival rates of small businesses around the world. It has already saved 300 businesses that would have gone bankrupt.
Should you or someone you know buy the book, please contact Dawn and she’d be happy to send a Numberphobic Study Guide as her gift.
Dawn Fotopulos is the associate professor of business at The King’s College, the founder of BestSmallBizHelp.com and author of Accounting for the Numberphobic: A Survival Guide for Small Business Owners (AMACOM). As an experienced entrepreneur and small-business turnaround expert she has rescued hundreds of small businesses from financial disaster. She has been featured on MSNBC’s Your Business and at the New York Times Small Business Summit.
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