A question we often receive from ongoing businesses goes something like this: My business is three years old and at times seems to be doing OK. My concern is that I sense Im not doing as well as I should. Where might I look to get a better insight into the health of this business?
Good sales and happy customers are not necessarily indicators of a healthy business. No doubt youve read about seemingly prosperous businesses some providing the same product or service as yours that suddenly shut down without notice.
Accounting and financial figures can provide you with information to gauge the health of your business and where it is heading. If you depend solely on your accountant, you are likely missing critical information. You need to become familiar with balance sheets and profit-and-loss statements. They are valuable tools that can provide the information necessary to make good decisions regarding sales, expenses and profit.
The balance sheet is a snapshot of your business at a given point in time. The amount of capital distributed over the various accounts in the business and the surplus of assets over liabilities generally show past profitability. If the snapshot shows that liabilities are greater than assets, you then see a loss position for the company at that time.
Even more important are trends over time. Comparing balance sheets over a period of time helps you to gain a fuller understanding of your assets and liabilities. By comparing these on an item-by-item basis, you can spot trends. You are now gaining a real understanding of the overall financial structure of your business.
A company may have a month of high expenses that results in a loss. However, trends may show five months of profitability. The net effect of the six months may be profitable, even though one month showed a loss. The concern is that if three months show a loss, then the owner must decide how to overcome the negative results.
Receivables may show a continuing upward trend when collection of outstanding accounts is running past the credit terms offered. Debt may run higher when the firm expands or makes capital improvements.
The profit-and-loss statement is another valuable tool in ascertaining the companys performance for a given period. The statement will show sales volume, costs and expenses incurred and the amount of profit or loss.
Comparing these statements for successive periods can be revealing. Why was there a lower gross profit for each of the several quarters? Did price cuts decrease per-sale profitability without increasing revenue? Was a higher proportion of sales spent on operating costs such as personnel, rent or insurance? Are overhead costs increasing?
Make sure, too, that you review the cash-flow statement. This statement reports collections and payments, namely, cash inflow and outflow. You need to make sure your checking account has a positive balance and that you are bringing in more cash than you are spending.
Although your accountant should be able to give you advice and guidance, you should also have a clear understanding of how to read, interpret and act on financial information. As the decision maker, you need to know what effect decisions have exerted on profits and what decisions will control costs, increase profitability and improve cash flow. The flow and use of money in your business is critical and depends on your ability to make sound financial decisions.
C. NORMAN BECKERT Idaho district director for SCORE, the Service Corps of Retired Executives