10 Financial Yardsticks for your Business

10 Financial Yardsticks for Your Business
by Joseph Anthony

Reprinted with permission from the Microsoft Small Business Center.

Recently I’ve been doing some work with a nonprofit organization. Somewhat to my surprise, I’m discovering that many of the money issues confronting this nonprofit are similar to those faced by small, for-profit businesses. Things like:

Understanding and keeping track of how much is really spent on various programs.

• Connecting expenditures to the revenues that result.
• Coping with basic cash issues (in its early years, the organization relied on loans from the people who started the group to carry it until money actually started to come in).
• Determining whether fundraising efforts actually cost more money than they generate.

 

All of the above have to do with knowing, or being able to find out quickly, where the money is coming in and where it’s going out. If you add in the profit motive, you’ve got what may be the fundamental — although simplistically described — day-to-day concerns of small businesses.

So I’m reviewing some of the financial measurements that businesses can use to get a clearer sense of how they’re doing. You can learn how to do these calculations by hand, calculator or by computer. You can also invest in a good accounting program that does most of the work for you.

One note: You won’t find any “preferred” ratios or figures in this article — ratios vary from industry to industry, and many of the so-called standard ratios that are used to measure the success of large companies often don’t work very well when applied to the smallest businesses.

And . . . attention, all nonprofits: While there are some characteristics that separate nonprofit and for-profit enterprises — like not paying income taxes — many of the basic principals for keeping track of your finances are similar.

Start at the source: What’s your cash flow?

Time and again, accountants and consultants who specialize in small businesses say that such enterprises don’t pay enough attention to cash flow, which is the measure of how much money you really have in the business.

“Small entrepreneurs wind up taking big orders that get them in trouble,” says Ronald Lowy, a professor in the Department of Business Administration at Eastern Connecticut State University. “They want the big contract, but they’re not getting enough money at the front end of it and they don’t have the cash reserves to pay workers and pay other bills while they’re waiting to get paid themselves. They might show a profit on an accrual basis, but from a cash-flow standpoint, they don’t.”

Judith Dacey, a CPA in Summerfield, Fla., calls a cash-flow statement “probably the most important thing in telling you if your business is on or off target.” She describes how board members of a nonprofit group in Jacksonville, for example, were not looking at their cash-flow statements.

“They were hiring people and spending money on membership campaigns, and doing all of these things based on money they thought they had from looking at the profit-and-loss statements,” Dacey says. “They didn’t realize that the profit-and-loss statement was an accrual statement, which basically means you are including paper promises of payments to come, not money that you have
in the bank.”

The nonprofit board became aware of the difficulty only when the organization bounced a check. Employees had to be laid off, and belts were tightened several notches.

“That could have been avoided if they’d ever seen the cash-flow statements,” Dacey says. “A cash-flow statement tells you that, hey, we know what the pretty numbers on the P&L say but here’s the cash that has actually come in and that you can work with.”

A statement of cash flow starts with the bottom of your profit and loss statement — the line that shows your net income. Several adjustments are then made to that number, including reducing the income by invoices recorded as income that have not yet been paid, adding back depreciation, adjusting for bills that your business has not paid, and several other adjustments. I’m not going to go into the details of the cash-flow statement —a good accounting program that does a P&L and a balance sheet will also calculate this statement for you.

Tracking the big 10

If you’ve established a way to track cash flow, then you can go on to organize and track 10 financials for your business. That’s a sizable list, but don’t panic: As with profit and loss statements, you can take advantage of software programs to automate tracking for many of the following:

1. What are your assets? Yes, yes, we all know that assets are the things that a business owns. Tracking your equipment, furniture, real estate and other holdings should be easy. But to have a true idea of the value of your business, you also have to track changes in the value of those assets. More than one small business has found itself located on a piece of land that’s worth more than the business itself. (Yeah, we should all have these problems.) Similarly, you also will want to track the declining value of assets such as computers and office furniture.

2. What are your liabilities? Again, on the face of it, this is easy — liabilities are what you owe. But what you owe isn’t always as obvious as a bill from your landlord. Payroll taxes are a liability that you might be able to put off on a monthly or quarterly basis, depending on the size of your payroll. Loans are a clear liability, but in repaying them you’ll want to be able to track how much of a payment is applied against principal and interest.

3. What’s it costing you to produce what you sell? If you’re buying a finished item for resale, this is relatively easy. It’s trickier if you have to calculate all the factors, such as labor, that go into manufacturing a product.

4. What’s it costing you to sell what you sell? Advertising, marketing, labor, storage and the catchall category of overhead — it’s useful to know how much it costs you getting a product out the door as well as what it costs you in creating it.

5. What’s your gross profit margin? This is calculated by dividing your total sales into your gross profit. If your gross profit margin is staying consistent or trending upward, you’re probably on track in terms of adjusting your prices appropriately to reflect changes in what you pay for what you sell or produce. Being able to track a declining margin can give you a heads-up that you must adjust your prices or your costs. In the worst cases, of course, your gross profit and your profit margin disappear altogether. At that point, you’ll be like the fellow who lost money on every sale but figured he could make it up in volume. Don’t go there.

6. What’s your debt-to-asset ratio? This ratio can let you know how much of the stuff you have in your company is actually owned by someone else — your lender. Having this ratio climb can be a bad sign — it can happen as part of a major expansion, but it can also indicate that you’re getting in over your head.

7. What’s the value of your accounts receivable? This is the money that you are owed. Value of being able to track it: If accounts receivable are on the rise, you may be getting a warning that the folks you sell to are starting to stumble. That’s especially true if your accounts receivable, as a percentage of total sales, are increasing.

8. What’s your average collection time on accounts receivable? This is probably one of the most aggravating pieces of information for cash-strapped businesses, because it tells you how many days you’re acting as “banker” for the people who owe you money. To calculate it, you’ll need to know your average daily sales and then divide that number into your accounts receivable.

9. What are your accounts payable? The flip side of accounts receivable. An increase in your accounts payable may merely reflect a policy of taking a little longer to pay bills, or of a larger amount of purchases overall. But an increase that hasn’t been planned or managed can be an internal warning that your company’s financial strength is waning.

10. What’s happening with your inventory?
There are occasions, even in this just-in-time business world, when building up a significant inventory can be a good thing. If prices for items you sell or use in production are relatively low, putting some of your money into inventory may make sense. Personally, I wish I’d stockpiled an “inventory” of a full tank of home heating oil last spring, when the price was around $1 per gallon. Being able to track your inventory, and how long it takes to be sold or turn over, can tell you whether business is increasing or slowing down. It also tells you how much money that might be used for other payments or investments is tied up in this unproductive asset.

Although tracking the big 10 and knowing what’s up with your cash flow is essential to your business, don’t be afraid to turn to professionals and outside services for help.

Patty LaPeters and Lori Siragusa started a business out of their homes in 1995. Today, they run Inline Technology Marketing, a full-service marketing agency based in Maitland, Fla. The most valuable thing they say they did to allow themselves to focus on acquiring new customers and growing their business: They outsourced all of their accounting and legal needs.

 

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