There is an awful lot to get done in the early stages of a business: there’s the product or service development, your online presence, customer definition, marketing message, videos, blogs, networking, and the building of your business systems. And, oh yeah, eventually you actually need to sell something. It’s easy to get bogged down and we sometimes forget that what we really need to do is generate revenue. I love clean systems and on-point marketing, but there are times you just need to ask:
What’s my shortest path to revenue?
My clients know that I like to cut to the chase and get right to the core, and this is never more true than when a business needs or wants more revenue. I once chose to work for a company that was close to bankruptcy because I wanted to see if I could help turn it around. They had some pretty cool products in development, and when I asked about how we would cover expenses in the next few months, I heard a lot of “well, if this happens….” Or “when we figure out this issue….” I don’t think I was making friends in those early days, because I would say “that sounds great, but what do we have to sell tomorrow?” “Which customers are most likely to want what we have right now?”
Being short on revenue is one of the most frustrating stages of business ownership and owners often feel powerless: that there’s nothing else they can do. We have to cut to the chase and ask key questions:
- What’s the shortest path to revenue?
- Is there a shortcut to revenue (without shortchanging service or quality) we can take?
- What steps can we bypass to get straight to revenue? Perhaps eventually we will add additional features or build out the missing elements, but when it’s crunch time you need to take the shortest line between where you are and what will produce revenue.
- The objection I usually hear is that it’s not ideal, it’s not what was planned. Taking a shorter path does not tie us to that path for ever, it’s just a path we choose for a period of time.
Keep building new products and services, keep filling your pipeline, but by determining the quickest path to revenue can keep you afloat while your are building your business, making changes, and growing your customer base.
Do you know which products or services are profitable and increase profit? Or, equally important, do you know which ones are costing you money?
Chances are you offer multiple product or service lines, and you probably know how much revenue each brings in (if you don’t, let’s figure that out first). Do you know which ones are the most profitable? Offering products and services that contain a healthy margin is essential to any business. Here is how to get started analyzing your current offerings and how to decide if a future offering will make the (financial) cut.
Step 1. Determine the Purpose: Deciding to offer a new product or service ought to begin with the basic question: what is the purpose of adding this product or service? The answer might be to make money, but stop and think about it for a minute; other valid reasons may be to increase sales of another product or service or to satisfy your customers and clients by making their lives easier, which increases their loyalty to you. You may want to be the “one stop shop” for your customers in your field; recognize that, and define your products and services with that vision in mind.
Step 2. Support your Goals: Once you are clear about your goals, it’s time to learn which product and service are meeting those goals. I once interviewed a large department store that’s policy was to only enter a new product line if the depth of that department could stand as an independent store in a mall. Can your products or services survive on their own, or do they rely on other products or services to survive? Let’s walk through an example:
Business: hair salon
Services Offered: hair styling, massage, and nail care.
Products Offered: hair and body care products.
Step 3. Allocate Costs: Each product or service should be recorded as a separate line item within the bigger category. For example: hair coloring would be a line item within hair styling and shampoo sales would be a line item within hair products, (which is within hair and body products).
Costs associated with each product or service should be recorded individually, within the bigger category: payroll for hair stylists is a cost of offering hair coloring as are the associated products.
Step 4. Determine Profit: To determine the true profit from each product or service line, allocate incremental overhead to each. True cost accounting would tell you to allocate a portion of all overhead costs; I think you get a clearer picture by only considering incremental costs.
Step 5. Review and Act: Review your stated goal for each; which products or services are not meeting your goal, which ones increase profit? Chances are you have products or services that are not meeting your stated objectives. Take a closer look to see where you can make adjustments. If you can’t, and your goal stands, it may be time to cut the product or service line loose. If you do, you just may be surprised by how much time and energy you save without losing any profit.
Last week we discussed two very important financial statements. This week, we are going to take a look at an equally valuable statement, cash flow. Small business cash flow, or the lack of it, is what most often causes a small business to fail. It’s easy to believe that if revenue is up, that your cash level will be, too, but that’s not always what happens. On your balance sheet, remember that assets equal your liabilities and owner’s equity. As any one balance sheet item changes, another element must change to keep the balance sheet balanced. Remember these basic rules (assuming no other changes occur):
- In order for cash to increase, some other asset must decrease.
- Cash levels will decrease if another asset increases, such as inventory or receivables.
- If your liabilities increase, cash will also increase. If you pay down your debts (liabilities decrease), your cash levels will decrease.
Looking at specific balance sheet items, here are the top three items you must watch to keep your cash position strong:
- Inventory. Increased inventory levels may cause a decrease in cash levels or an increase in accounts payable; either way, an increase in inventory that doesn’t turn quickly will cause a decrease in cash.
- Accounts Receivable. Increased sales may become an increase in customer balances due you (Accounts Receivable). You’ve paid for inventory or payroll but haven’t yet received cash from your customers, which causes a decrease in cash levels. In a desire to increase sales, be careful not to unusually extend credit; this can cause a cash crunch not easily resolved.
Inventory levels and customer receivables often grow as sales increase; cash levels can decrease quickly if you don’t keep a close eye on them all.
- Accounts Payable. Slowing down payments to vendors can help cash in the short term, until vendors demand cash on delivery. You then are paying for new stock without having paid for inventory on hand. Be careful not to build inventory levels for which you don’t have the cash to pay for.
Don’t let this basic financial statement, your Statement of Cash Flow, confuse or overwhelm you. This is basic math: as any asset or liability changes, another item, such as cash, must also change. As revenues increase, watch your inventory, receivables and payables especially and cash will remain strong.
Reading and understanding your small business financial statements is right up there with root canals for many business owners. If you don’t regularly review your financial statements, though, disaster can be right around the corner and you may not even know it.
I’ve wanted to provide a Small Business Financial Statement 101 review for quite a while now, but how do I do it without you nodding off? And besides, the SBA has explained the elements quite well already (see http://www.sba.gov/ombudsman/7046 for detailed descriptions of balance sheet and income statement elements). So instead, let me give you a broad view with quick tips on what you need to be paying attention to.
Income Statement, or Profit and Loss Statement
If you review any of your financials, chances are this is the one you look at. Basically, this is it:
Revenue – expenses = net income.
So, where is the starting point for reviewing this statement? Give every line item a critical review, understanding that if you want to increase net income, one of the other two items – revenue or expenses – must change. You should be looking at it
monthly, compared to the same month last year and to your budget; also review it on a year-to-date basis (and compared to YTD last year and your YTD budget).
That’s a start, but this limited view has its downfalls. Your income statement is historical and has little to do with a critical small business need: cash.
Your balance sheet is a snapshot in time, and shows what you own, what you owe, and what’s left over AT A GIVEN POINT IN TIME. Key items to pay attention to:
- Current Assets compared to Current Liabilities. If necessary, could you cover all of your short term liabilities (what you are required to pay within one year) with your short term assets (what you can turn into cash relatively quickly)? Watching this ratio (called your Current Ratio) will prevent excessive debt, which can quickly turn a business into a mess and even non-existence.
- Accounts Receivable. Consider accounts that owe you money as your customer loan department. If you have provided a service and have not yet been paid for it, you are basically loaning your cash to others. Make sure the business transactions warrant that “loan”.
- Inventory. It’s easy to fall into the trap your distributor reps often set: buying more of an item, giving you a better unit price, is not always a good thing. Inventory is equivalent to dollar bills sitting on your shelf. Make sure inventory will turn quickly enough to provide the income needed to pay bills, provide for you and your staff, and invest further in your business’s long term health.
- Accounts Payable/Loans Payable. This represents what is due to vendors and lenders in the short term, keep this balanced between maximizing the “loan” you take from your vendors with too much debt and keeping your vendor relationships strong. Avoid letting this number creep up without increased sales and cash flow.
To most business owners, small business accounting is like eating your veggies; you don’t really enjoy it, however you know it is good for you, and you feel better after it’s done. It isn’t the most fun or exciting thing to do, so it is easy for the task to but pushed aside for another day. Small business accounting can be confusing, time-consuming and downright frustrating (isn’t that why you hired a CPA?). However, it doesn’t have to be as hard or painful as you think! You can discover a ‘wealth’ of information if you know where to look and how to read the statements. (Need more help on this topic? Check back next week for tips and tricks on reading statements)
Let’s start by breaking down what is most important in small business accounting analysis. Your time is valuable, and in short supply, so let’s focus on the statements that will yield the biggest bang for their buck. Below is a list of financial statements that I want you to see, and review, regularly:
- Income Statement, (also called Profit and Loss)
- Balance Sheet
- Operations Dashboard
Like to Have
- Statement of Cash Flow
- Customer List sorted by Revenue
- Product/Service Line Profit and Loss by month
- Key Financial Data by Month since Inception, recorded to allow reporting of year over year data (comparing same month, different years)
- Key Operating Data by Day, to allow comparison of operating data by day of week, by week. What I really want is for you to see your key items sliced in any possible way you can imagine. This requires some up-front thinking and analysis and someone good with a spreadsheet.
- Key Ratio report showing monthly trend
This list may seem overwhelming at first, but once you get into the groove of reviewing statements, it becomes painless and eye-opening. Don’t know what to look for when reviewing these statements? Check back later for the next post detailing more small business accounting tips and how you can use statements to grow, prevent disasters, and increase your cash.