In 16 years of public accounting, I was always amazed and perplexed at clients who had no clue how their business was performing—not from an operational perspective, not from a market place perspective, but rather from the most important way, a financial perspective.
They didn’t speak in terms of profitability or financial strength, but often simply in terms of sales or how much cash was in the bank. Gross margin, current ratio, earnings before interest, taxes, depreciation, and amortization (EBITDA), and their debt to equity ratio were foreign terms. Rather than try to learn—let alone “intimately understand”—what these mean and why they’re so important to the lifeblood of the business, the owners often avoided a detailed financial review of their income statement, balance sheet and statement of cash flow and would rather speak in terms of glib and or irrelevant data.
Think of this logically: unless your business is completing failing and hemorrhaging cash, you can’t have negative cash. It is either a zero balance or better. However, if your accounts payable is continually rising, that could be an initial warning sign of problems. Maybe the reason you have cash in the bank is that your aged accounts payable has grown from 20 to 45 days. That will NOT make your vendor partners thrilled. Therefore, don’t just look at cash, but the ratio of what you have in the bank (or other current assets such as inventory and receivables) and compare that against all invoices that are due within 30 days. That analysis is much more meaningful.
Most of us are sports fans. Can you imagine going to a sporting event, intimately watching an entire game, cheering for your favorite team, and NEVER looking up at the scoreboard? Just like in sports, understanding the financial side of your business is one of the most important parts of being a business owner. An income statement—or a profit and loss (P&L) statement—acts as your scoreboard, giving insights into the financial condition of your business, while a balance sheet provides keen insight into your financial position at any specific point in time. You should look at both regularly to fully understand how your business is performing.
Be a Planner.
You would never take a vacation without a proper plan. Flights, hotel reservations, where to eat and what to do when you arrive are all things we plan and yet take for granted when we go on a trip. However, many business owners begin the year without a detailed formal budget that they can use to evaluate overall success or failure. If you don’t have a roadmap for success, you’ll certainly get where you are going. Think about that.
Each month, you should be comparing how you did with how you thought you were going to do, and you should have a good idea of what your P&L statement is going to look like each month. Surprises mean something is wrong.
Without consistency, your P&L statement won’t be relevant. The format you choose should easily show how your business performed compared to how you expected to perform. For example, at Penn Station, we require franchisees to submit their P&L statements in a prescribed format by the 12th of each month. This allows us to compare each location separately and in aggregate, segregated by market and sales volume, giving franchisees a chance to compare themselves to their peers. Without consistency in recording, a comparison between franchisees wouldn’t be possible because the differences in the documents would be too difficult to overcome.
Consistency from month to month is also crucial. If you change where you categorize an item each month, you won’t be able to watch for trends.
For financial data to be relevant, it must be timely. If you don’t look at your P&L statement at the right time, you will miss the opportunity to make key changes to improve your business. Take employee wages for example. If your employees are paid on the 1st and 16th of the month, but you don’t look at your P&L statement until the 20th of the following month, you’ll have missed the opportunity to make any adjustments if necessary. If wages are higher than expected, you may need to adjust the hours your employees work at the beginning of the month. Waiting two or three weeks to make this decision could cost you money while you are paying hourly employees more than you should. This also goes for items like inventory levels or advertising expenses. You’ll miss several weeks of potential savings if you don’t review your P&L statement at the beginning of the month.
If you simply put expenses in the miscellaneous category, you won’t get much value out of your P&L statement. Find a home for each expense and be as specific as possible. Look for variances and anomalies from month to month, and if you’re in a franchise, look for these compared to your peers.
Be specific in your balance sheet as well, and don’t ignore it. It is a good gauge for your cash and liquidity situation and can help you monitor problems. For example, your P&L statement could look good, but your balance sheet may show a problem with the inventory levels. The opposite is also true: your balance sheet may look good, but your P&L statement could show growing accounts payable. Studying both financial documents is key to success.
By creating, maintaining and monitoring accurate P&L statements and balance sheets on a timely basis, you’re giving yourself a chance to pinpoint potential issues in your business. For example, if payroll taxes are higher normal, it might mean a business has an above-average turnover. That allows you to look closer at training and operations to see why turnover is high and fix the problem. The financial statements tell a story, and the more you read them, the better you understand them and the better your business can perform.
A franchisor should be selling your profitability when you join the system. They need to care about your profitability and success, not just top-line sales. This means they should be focused on helping you succeed and be interested in your P&L statement. By requiring consistency and timeliness in financial reporting, they allow you to compare yourself to your peers, giving you a better chance for success.
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