Articles
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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