When I examine the financials statements of a business, privately held or public-traded (read: it doesn’t matter if you’re small or big), I look for the follow attributes…..
Consistently increasing revenue – Sales don’t have to be up every year, but the long term trend should indicate consistent upward growth.
Healthy gross margin – This is a tricky one because it’s so unique to the industry. So let’s agree that as a starting point, GM needs to be better than the industry benchmarks. Anemic gross margin could be a sign of significant competitive pressure, or lack of competitive advantage. These situations lead to cut-rate pricing or significant discounting, which is not part of a healthy business.
S, G & A or overhead expenses that are 30-60% of gross margin. Remember that this is before interest, depreciation, and other expenses. There’s quite a range here, because some businesses are more capital intensive than others. Some businesses require constant reinvestment in equipment, facilities, tooling, etc. While other businesses, such as accounting offices, require little capital investment.
A return on equity that is consistently moving upward. This tells me that the business is disciplined. In other words, they have the discipline to keep tamping down overhead expenses, and the foresight to actively reinvest in their business cycle.
Little spending on R&D; and not to be confused with innovation, which is critical to the business growth cycle. The organization must maintain healthy financial results, stave off competition, and grow market share without constantly reinventing themselves, or without relying on the next break through.
If you can’t manage the flow of cash in your business, your business is out of control. Control the cash flow and you’ll control your business. I hear new clients talk about not having enough money to make payroll, that’s a cash flow management problem. That’s different from profit. Many businesses have shut down, even though they had a profit on paper, because they had poor cash flow.
It doesn’t matter how big your company is, or how fast your profit (or sales) are growing. If the money isn’t there when you need it, you’re history. So the first step is to understand that profit, as represented on your Profit & Loss statement is a static number. Think of it as a sort of history lesson. By examining your P&L, you will only understand where you’ve been. Cash flow on the other hand, is dynamic, ever changing and always on the move. If profit is like reading the newspaper, cash flow is like watching a movie.
Your P&L tells you how much money you’re spending and receiving and where you’re doing that. Cash flow tells you the same thing, and also when you’re spending and receiving it, or can expect to spend and receive it. That’s the key difference. Forecasting when this flow in and out of your business happens, or will happen, is what a cash flow statement does. A successful business is great at forecasting and also at efficiently managing the flow in and out.
Here’s an example of inefficient, or poor flow management: your customer owes you money on net 15 terms. On day 25, the money hasn’t arrived, on day 30 you send out a statement, on day 45 half the money comes in, on day 60 you send out another statement, and so on.
Managing for profit requires that you pay attention to your pricing strategy, gross margin and overhead expenses. Managing for great cash flow is an attention to the details of timing. Knowing where and when your money is flowing it crucial to beginning to understand how to control the flow.
After a hectic couple weeks of travel, while working with clients to close out their 2011 accounting records, and begin financial strategies for 2012, I was struck with one big takeaway theme. From all of these meetings I’ve attended, there has been a common decision (or resignation) by almost every client to raise prices and improve gross margins.
There may be several reasons, but I have a hunch that it will boil down to two. When the fourth quarter results are all in, I’ll know for sure and will keep you posted. The first reason is that my clients have been on a steady path to improve product offerings in an effort to increase gross margin; otherwise known as innovation. The four basis steps they follow are:
1. Innovate – to identify better ice cream, faster delivery times, more effective backup systems
2. Smoother the client and prospective client base with service
3. Inch up prices
This is a simple process, but will usually involve some gut-wrenching decisions and risk taking. On client had to kill a type of health care program designed for teenagers. It was a logical extension of his successful program for adults. After investing countless hours preparing and marketing, it never panned out and he walked away from the significant investment, to spend his time more productively on newer ideas.
The second reason our clients are willing to raise prices and improve gross margin is more subjective. I believe that after weathering three years of a recession, most of the competition that was habitually discounting prices to stay alive, is now gone. A recession has a way of shaking out weak players. What’s left are generally solid businesses that have more latitude to raise prices.
What’s been your take on the last fiscal quarter? Are you more or less optimistic that you were a year ago?
IRS agents are starting to request accounting backup files from small business accounting software such as QuickBooks and Peachtree. The obvious concern is how much information the IRS is requesting and how it is using that information.
Since 2010, the IRS has been training revenue agents to be proficient in using QuickBooks, Peachtree and other similar accounting software packages. These agents are encouraged to request electronic files from small business taxpayers and their accountants.
There have been court challenges to these kinds of requests and exactly what kind of audit that would require an electronic backup file is still being sorted out. For instance, questioning a handful of business expenses probably would not warrant a request for your QuickBooks files, but larger-scope audits may trigger this kind of request.
There is a concern that corrections and adjustments within the accounting records, no matter how legitimate, may lead the IRS agent to question the integrity of the books in question. Sloppy bookkeeping that must later be corrected by an accountant could draw this sort of red flag.
Right now is an excellent time to switch payroll service providers. We’ve found that new clients begin working with Ashgrove payroll for a few reasons:
They are tired of getting notices from the state or feds
They want to save money – we generally cut the payroll service fee bill by 30-50% from other providers such as Paychex, ADP, Prime Pay, etc.
They want to be able to pick up the phone and get an answer right away.
Automatic download into QuickBooks, Peachtree and other major accounting software packages for free.
Besides having piece of mind with the payroll function in your small business, we add value to this by offering excellent time keeping systems, analysis of labor costs, and advice on pay rates based on job functions and responsibility.
Contact us today to learn how you can have peace of mind in 2012 with your payroll. You’ll never have to worry about it again.
One of the least understood financial measures, at least by the business owners I work with, is their working capital requirement. When examining accounting records, it is simply the business recievables plus inventory, subtracted from payables and payroll liabilities (with some minor exceptions). It’s called working capital requirement because many businesses are required to use internal money to support this spread. In other words, money is tied up waiting for customers to pay up(receivables), and also tied up in inventory. This is subtracted from the fact that you owe your vendors money, which effectively becomes your bank.
In some rare cases, such as some retail businesses, working capital is a negative number. This means that the working capital cycle produces cash; products are sold to customers before they’re paid for. Several years ago Home Depot insisted that all vendors get paid when the product is rung up at the cash register. This brilliant move essentially removed all inventory from the operation, giving Home Depot a tremendous advantage.
How you finance this lack (or difference) in cash is debatable, but knowing and tracking your working capital requirement is important because it can help resolve cash flow issues. Like many topics related to small business financial excellence, it goes back to a decent accounting system and an eye for details.
One of the best ways to improve cash flow is to collect the money owed to you, sooner. Many small businesses overlook the basics of accounting and bookkeeping principles. These ideas apply to all companies, whether you live in Raleigh North Carolina or Madison Wisconsin.