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Using Your Financials as Your Crystal Ball

Financial experts share which reports really matter – and how to use them to divine your company’s future What Your Financials are Forecasting The future of your business can be read in what your financial reports tell you today: Whether or not your business is doing well. Whether your customers are paying on time. And, even whether your office supplies are going missing.

“It’s important to take a good review of the financials either on a weekly basis or on a monthly basis,” explains Robert Tamburri, Vice President, Finance and Investments at GV Financial Advisors. “And take a look at the key parameters that help make small firms successful. That would be financial statements such as the profit and loss, the balance sheet and the cash flow statement.”

Despite the predictive power of financial data, Robert has noticed that many business owners are not reviewing them regularly. The reason? Reading financials is simply not why many entrepreneurs started their business, so they may not enjoy it. They also may not have the accounting processes in place to make it easy to do.

“Business owners, whether they realize it or not, are leaders. A common fallacy about leadership is the facade of invulnerability,” says Michael S. Blake, CFA, Valuation Associate at Adams Capital. “Reading financials is hard, and it takes years of training to really do it very well. Business owners don’t want to admit that they are not very capable of reading their own financials. It can be easier to stick your head in the sand.”

Entrepreneurs uncomfortable with finances should find either a business partner or employee who really does enjoy finances, and/or read accounting books or takes classes or seminars. They should also build in the processes to review key financials regularly.

“It’s important to look at cash, billing and accounts receivables, and sales pipeline,” adds Michael. “If you’re in a hectic week and you have no time to look at anything, then as long as you look at those three things, you’re going to be in pretty good shape most of the time.”

Critical Financial Reports in Detail

Cash Flow

It really is true: cash is king.

“If you want to know what the value of an asset is, figure out the kind of cash it’s generating and that gives you a pretty good idea,” says Michael, whose company determines the value of companies

. Of course a positive cash flow is wonderful, but it isn’t always the whole story. In addition to cash coming from operations, it’s important to look at cash from investment and financing activities.

A positive cash flow can be quickly eaten up by investments in machinery, marketing or computers.And it wouldn’t necessarily show up on other key financials such as the Income Statement.

“Two companies that have identical operational cash flow and income may have wildly divergent values if there’s a big difference in what their required capital investment is over time,” explains Michael.

Robert warns the reverse can also be true. Fundraising could be masking the fact that operations is losing cash. “Depending what stage the company is in, you could be raising money or you could be spending money,” he says. “But that could be covering up the fact that your core operations are actually going negative.”

Profit and Loss (Income Statement) & Balance Sheet

These reports provide a clear snapshot of the business and help owners understand how the company is doing over time.

Robert will review these financials monthly. “I’m checking our overhead and costs of goods sold – what we pay our vendors,” Robert says. “And the condition of our balance sheet, which would be our receivables, cash and other fixed assets.”

He also checks for trends over three to four months, or annually during budget time. This allows him to track down the operational reasons for numbers that have changed. For instance, higher spending on office supplies could be a result of an unlocked supply closet or lax ordering.

“I’m really getting my head into the data to see: Are there trends that are coming out of the last 3 months – any warning signs?” he says. “With small firms, overhead can really creep up on you. Office supplies, they add up. It could lead to some operational set up concerns that you may have in the company. It’s effective to get those to the management meetings.”

Accounts Receivable

With accounts receivable business owners should be looking at the aging – how late customers are paying. Great sales numbers can bolster other financials. But if it can’t collect, the business is in trouble.

“I’ve worked with lots of companies that have shown lots of sales on the profit and loss and income statement and then you look at the accounts receivables and you see it’s a disaster,” says Michael.

Factoring firms (also known as asset based lending firms), that lend money against accounts receivable, generally don’t fund accounts older than 30 days. But for an owner looking to pinpoint operational issues, accounts older than 60 to 90 days are red flags – and may not be collectable.

Like on other financials, once undesirable aging numbers are clear, managers must investigate the operational reasons behind them. Late payments can signal poor collections procedures, late billing or overly aggressive sales tactics.

“If you go into the actual purchase agreement you may see that there isn’t as much of a compulsion on the buyer to pay,” explains Michael. “And sometimes you get that because sales people are trying to meet a quota. Sometimes you get it because a company is acting desperately. Sometimes you get it just because the company has some sales processes that need to be looked at and tightened up.”

Sales Forecasting

A weekly look at what’s in the sales pipeline will help owners understand where and whether money will be coming in over the long term. It also helps owners make sure the sales process reflects the business strategy.

“Sales people are creatures of motivation, creatures of the short term by nature and if you let things slide for three, four weeks at a time without checking in and holding people accountable, you could wind up having some surprises that you’d rather not have,” Michael says.

It’s important to understand the entire pipeline, including number of leads and prospects – and the potential sales value. Michael cautions that a sudden increase in big ticket prospects might actually be bad for business.

“One warning might be if all of a sudden you see a shift to lots of leads that are going to be very big,” he says. “That’s something you need to look at very carefully because that can be a sign that sales people are starting to try to reach for the low probability but high dollar volume sales. Often if you go to the home plate trying to hit a homerun you’re much more likely to strike out.”

Your Own Industry Metrics

In addition to these standard reports, there are figures that foretell success – or trouble – in specific industries. In Robert’s industry, for example, “assets under management by financial advisor” is key. In an existing business, mangers can simply track numbers from years past.

But for entrepreneurs finding those telling numbers may be a challenge. Robert suggests finding fellow owners through local affiliations or a retired executive from your industry who can mentor you. If that’s not possible, look for books or executives in similar industries.

“These people will have a long-term history of knowing the types of markups, the types of overhead percentages, the historical data in that industry,” says Robert. “No entrepreneur can just go into managing financials blindly unless they have some type of understanding of what those benchmarks should be.”

To make sure financial goals are based on real market conditions, Michael suggests using both mangers and staff to determine them.

“In order to meet those projections, it should be a collaborative effort with all the stakeholders involved,” explains Michael. “You don’t want to set those benchmarks from on high because if you don’t have a day-to-day feel for the marketplace, you may very well be setting benchmarks that are either too high or too low.”

Use Financial Processes to Manage the Future

Beyond reading reports, the right processes can make managing the company’s finances easier. Once owners build the right strategies to understand their financials, they can then look for the technology and tools that best fits those processes, says Michael.

For instance, Robert suggests that owners review checks every month to understand who the company is paying. That’s because one way employees embezzle money is to create fake vendors. He also suggests that the person who writes checks does not do the reconciliation.

[Embezzlement is] not a big problem, but it’s a quiet problem,” Robert says. “The people who typically embezzle at small companies tend to be loyal, long-term employees that do a fabulous job, and then seven or eight years later you find out that he or she has been stealing from you for a long time.”

But with the right corporate culture, employees can help a company reach its goals by consistently providing valuable information.

“That’s a process that everyone in the company should be contributing to. If I’m a sales person I should be prepared at any time to tell my boss: what’s in the sales pipeline, what’s the status? Is there anything we need to do to move that sales process along? If we lost an engagement: why? What can we learn from that process?”

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Using your financials as your crystal ball

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