A great product, smooth operations, and great people are important indicators of a successful company. However, if the business is firing on all cylinders, but financial tracking and reporting are lackluster, is the company truly prosperous?
A former boss kept his business financial statements on the front of his padfolio. He referenced the financials regularly and his business decisions were based on maximizing sales, reducing expenses, managing cash inflow and outflow, and creating massive profit.
Profit and cash flow management are crucial to every business’s success. If sales are record-breaking, but the cost of producing revenue diminishes margins, the business is not winning. If there is a windfall of revenue and new opportunities, but cash flow is not well managed, the business can run out of money before service delivery can even start.
We are in business to make a profit. After the owner has done all they can to produce sales, reduce expenses, and manage cash, net income must flow to the bottom line.
Here are a handful of key financial indicators that lead to a healthy business:
Profit and Loss – Best practices suggest that every business owner should keep a log of all income and expenses, either through a handwritten ledger or an online bookkeeping software. Online software is helpful because many expenses can be automatically categorized and entered into the profit and loss statement (P&L). Hiring a bookkeeper can also help with this process. A profit and loss statement indicates the business’s sales, cost of goods sold, operating expenses, and profit. The P&L shows whether the business is making or losing money.
Break-Even Point – The break-even point (BEP) tells an owner at what sales mark the business starts making profit. The way to calculate a break-even point is to add the direct cost of delivering services and operating expenses together. Once an owner knows that number, they can back into how many sales are required to cover the cost of goods sold and operating expenses. The goal is for the business to cover expenses monthly, and then drive sales to create profit above and beyond the break-even point.
Working Capital – This refers to how much money it costs to run the business on a monthly basis. This number is similar to the break-even point, but is based on the balance sheet. Working capital takes into account the average of current assets minus current liabilities over the course of a year. In addition to sales covering break-even monthly, a company should plan to reserve cash to cover at least three months of working capital.
Cash Flow – Business owners can fall into the trap of having enough cash for today, but run out of cash the next month. The cash flow statement is a planning tool that business owners can use to make sure they have enough money in the bank. The statement also reflects how much cash is expected to come in from outstanding invoices. Good financial management strategies suggest forecasting cash receipts at least three-months into the future. If the cash flow statement does not at least cover break-even expenses, the business will be in hot water quickly. This statement can also give a business owner insight into how much sales needs to increase, or expenses need to decrease, in order to create plans to profit in advance.
Accounts Receivable Aging – Every business owner should know how long it takes to collect on invoices. This is the company’s accounts receivable aging. A company could invoice $1,000,000 on the first of the month. However, if it takes clients months to pay, aging receivables can cause a cash flow problem. Strong financial managers know the average length of time it takes to receive payment from invoices, plan for cash flow accordingly, and implement strategies to shorten the length of time it takes to collect.
The key financial indicators above are simple to understand and compute. However, many business owners fail at business money management because they are too busy running the company. However, running a strong organization requires the business owner to manage cash, expenses, and profit daily.
Be like my former boss. Compute the financials. Carry them with you. Run your business by the numbers. Reduce expenses. Increase sales. Cover the cost of doing business.
Then, maximize profit.
Jamar Cobb-Dennard is a business broker and M&A attorney. To learn more about how to buy and sell companies, contact Jamar at jamar@jamarcobbdennard.com. For more from Jamar courtesy of the Indianapolis Recorder, click here.
