You Have to Know Your Numbers To Keep the Money You Make

The vast majority of small business owner’s don’t receive regular financial reports from their accountants. And according to Chuck Kremer and Ron Rizzuto, authors of Managing by the Numbers, 90% don’t know how to interpret that information or use it.

Well guess what?

That attitude will catch up to you.

Your business will grow beyond the stage where just keeping an eye on your bank balance isn’t enough anymore. You’ll take on more employees and overhead. You’ll invest in projects with a slower return. And your “machine” will be much more complicated.

Your job as the business owner is to steer this ship. Guessing and instinct won’t work anymore.

The good news is you don’t have to be an accountant to master this stuff. Fortunately, my  background is in financial services. I had to have a basic understanding of business accounting to pass my securities exams. But that was the extent of it. 

But one of my strengths is that I’m never ashamed to admit I don’t know something. Willful ignorance is shameful. Asking questions never is. Don’t be afraid to start small.

Understanding your business numbers is about much more than just knowing where your money is coming from, or making penny-pinching budgets. You’ll be able to quickly gauge the health of your company or business over a given period of time. And you will also be aware of your spending patterns, and of cycles in your sales — periods of higher sales and dry periods when you should expect a dip in revenue.

At minimum, the three key reports you need to understand are your Balance Sheet, Income Statement and Cash Flow Statement. Keep a close eye on these three numbers in particular:

• Net Profit is captured on your Income Statement. It tells you whether or not you’re making money — in other words, whether your sales exceed your costs over a given time span. But be aware that this number can also be distorted by variations in cash flow, so you’ll also need to track OCF.
• Operating Cash Flow (OCF) is captured on your Cash Flow Statement. If your OCF is consistently positive, you know you’re generating enough cash from operations to meet your regular expenses. If your OCF is consistently larger than Net Profit, it also indicates that you’re doing a good job of turning your profits into cash. If you don’t have a healthy OCF, you’re on the way down — even if you’re showing profits.
• Return on Assets (ROA) is calculated by taking the Net Profit from your Income Statement and dividing it by the average Assets from your Balance Sheet. (To get your average assets for a given time period, add together the assets from the start of the period you’re tracking and the assets at the end of the period and divide by 2.) ROA tells how well you’re doing at managing sales and expenses, and how effectively you’re managing your assets.

If you want to make these statements work for you, you need to track them over time so you know whether your performance on these three “bottom lines” is improving or declining.

I’ve requested a Balance Sheet and Income statement to be prepared for me every 6 months, and a Cash Flow Statement every month.

When you learn how to read your financials, I bet you’ll also discover some things that seem totally counterintuitive to you.

For example, you might think that to make more money you should just create new products to sell. That makes sense, right?

I thought so too. But it turns out that three to four months goes by from the time you first start investing in production to the time you make our very first sale. That’s called your Operating Cycle, and it doesn’t just matter for manufacturers or brick and mortar retailers. It turns out that you are were carrying the costs of new product development for several months. Your cash flow had to sustain that. The Return on Investment for new products is also much more gradual than I previously believed, so it can take much longer than you realize to make a profit on them.

If you don’t understand these cycles in your own business, you can suddenly find yourself pinched for cash — and pinched for sleep too when those 3am worries set in.

Tens of thousands of businesses go under every year while still turning a profit, because they didn’t know how to track their Cash Flow.

Understanding your numbers will keep you out of these traps. And it’ll help you get the most from your accountants too. You’ll know exactly what information to ask for, and exactly which reports you need in order to increase your profits quickly and systematically. You won’t be flying blind anymore, because you’ll know precisely where those funds should be invested to fuel growth.

If you’re just starting out — or if you’ve been at it for a few years like I have — go online and pick up a stack of books. The two that I mentioned in this article are a great place to start. Block out some time and study this stuff. And then sit down with your accountants and ask questions, even if you think it sounds dumb. That’s your job as a business owner. And it’s all part of transitioning from that “start up dream” to a mature business.

I promise you it’s not difficult. It’s like learning a new language, or cracking a code. You’ll be amazed at the patterns you start seeing in your figures. You might even find you enjoy it, like I did. You certainly will appreciate your efforts at your next accounting meeting, and every time you look at your bank account.

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