6 Keys to Understanding – and Leveraging – Your Financials
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Tracking your financials is kind of like eating your vegetables: It may not be the tastiest part of running your business, but it’s good for your company – in the short term and the long.
Financial indicators can tell you a lot about your company’s performance. And more than that, if you understand and focus on particular metrics, you can use them to enhance day-to-day business operations and as strategic tools for moving your enterprise forward.
To be in command, stay on top of the following six types of financial metrics:
The two basic ratios
One of the most important things for you to know about your enterprise: Is my head really above water? Am I better off financially to be in business or not? To determine that, you need to look at your balance sheet as well as the profit-and-loss statements that track daily income and outgo.
Your balance sheet will reveal two crucial ratios: the current comparison of assets to liabilities, and equity to debt. Ideally, both should be two-to-one, and you definitely can’t afford either one to be negative.
“Many times entrepreneurs will be running at a loss, but they don’t feel it or see it because they’re delaying payment of payables or pulling on a credit line to finance a loss,” says Sandy Abalos, a CPA in Phoenix. “The key to improving both numbers is to reduce debt.”
Snapshot of your cash flow
Cash is king in business, so you need to know month-to-month that your cash flow is positive. Determine how much you need to sell or bill each month to keep you and your business going, and hit that number every time – whether it’s by delaying expenses or pushing for payment of accounts receivable.
One way to avoid cash-flow bottlenecks is to invoice on the basis of a percentage of goods shipped or a project completed rather than waiting until you’ve provided an entire order or finished a billable task.
Digiwaxx Media, a digital-music service for DJs based in Harlem, N.Y., tries to avoid cash-flow hiccups by moving as many of its accounts as possible to online credit-card payments. “It costs us 2 to 3 percent for the processing, but it really boosts our cash flow compared with waiting for someone to send and write a check,” says CFO Neil “Nifty” Caesar.
Experts and entrepreneurs differ on whether using accrual-basis accounting is a good idea. It gives you a more accurate overall picture of your business by smoothing out month-to-month fluctuations. But accrual accounting also can obscure trigger points for cash-flow crises.
“Blow off accrual accounting,” advises Alex Ramsey, president of LodeStar Universal, an executive coaching firm in Dallas. “It’s stupid for a startup’s management. Know where the cash is and where it’s coming from in the near future and balance it.”
If you have more than a single product or more than one level of service, you can leverage margin differentials to maximize profits. Most decent accounting software will help you figure out the differentials.
“Target customers with your sales plan who are going to favor your highest-margin items,” advises Tom Bayer, a CPA in Springfield, Ill.
But don’t discount the value of being able to gather low-hanging fruit that provides a steady stream of revenues though the margins are low. “You may want to have a healthy mix of those two types of (products and services) and then try to go after both, not just one or the other,” says Cindy Anderson, a CPA in Raleigh, N.C. “One type leads to the other in many cases.”
Classification of fixed and variable expenses
You need to understand which expenses you must incur, which are fixed and which expenses differ depending on your production and sales activity, which are variable. Fixed expenses indicate your break-even point, a number that’s crucial to know as you tweak your business.
“If you’ve got a picture of your fixed expenses, you can know how much money you need to set aside for that rainy day,” Anderson says.
Seasonal and cyclical variations
Many startups face wide discrepancies in revenues depending on the season and, to some extent, macroeconomic cycles. Some experts suggest accrual-basis accounting as one way to help you to spread out the financial impact of seasonality over the whole year.
“You need to be productive and be able to build your inventory during the down times to be able to gain strategic advantage when your sales season hits,” Bayer says.
But you also should work actively to even out the fluctuations. There’s no substitute for battling seasonality by “counter-programming” your business. A classic example is a lawn-care business adding snow-plowing in the winter.
Status of sales and marketing pipelines
Some of the most important numeric indicators on your dashboard don’t have dollar signs attached to them, per se: They’re measures of the success and productivity of your sales and marketing.
Regarding sales, how many phone calls does it take to get a certain number of appointments? To get a certain number of requests for proposal? A certain percentage of deals? Track these numbers and make the necessary adjustments in your operation.
You can do the same thing with many marketing expenses. If you have a store, for example, experiment with different types of advertising, then measure floor traffic to see which gets the best response.
“Knowing these numbers, you can control the causal agents that are the leading indicators of how your business is doing,” says Lanny Goodman, a small-business consultant in Albuquerque, N.M. “Dollars and cents numbers are lagging indicators.”
Our Bottom Line
Poring over your financials isn’t as fun as closing deals or developing new products. But it’s a necessary discipline for startups. And doing it right, using these six measures, can give you an important lever on managing your business.