Compiled and Edited by: Meredith Wood Bahuriak, NuZoo Media
Few people start a business because they are good with numbers. In fact, the terms “accounting” and “financial analysis” tend to put business owners to sleep or send them screaming from the room. But to run a business effectively, most owners need to have some understanding of their finances.
It is, for example, entirely possible for a company to be profitable but fail anyway because it does not have enough cash coming in to pay its bills.
It’s like a racecar that goes too fast and runs out of gas. Business owners do not necessarily need to know how to prepare a balance sheet, but they do have to know which gauges to watch.
One obvious step is to work with a bookkeeper or accountant, someone who can help navigate arcane accounting and tax rules and organize your affairs. But owners should understand that accounting is not just about paying taxes or reporting results.
What follows is a guide to better understanding the numbers that drive a business. As the examples make clear, even smart people with advanced degrees can become confused by accounting issues.
1.) DON’T MISTAKE DEBT FOR PROFIT
To finance growth — many business owners increase supplies, for example — and keep borrowing money from the bank, not realizing that the more grown, the more money needed to borrow because the revenue does not cover the expenses. The loans mean money accounts — but it’s borrowed money.
2.) MANAGE RECEIVABLES
One number that can look impressive is the company’s accounts receivable balance, especially if it’s more than $100,000. But, that is money owed by wholesale clients. Upon deeper investigation many of these accounts may be stale accounts and overdue. By making sure customers cannot buy more until they pay for what they had already bought, you give your customers an incentive to pay up.
3.) UNDERSTAND YOUR EXPENSES
Many people believe they need to spend money on advertising, but how much is too much. It can become a vicious cycle where the more revenue you take in, the more compelled you feel to more adds to land additional clients causing expenses to increase faster than revenue. By cutting advertising you could raise prices on clients because you are devoting more time to them.
4.) TRACK YOUR BREAK-EVEN
Seize upon the notion of tracking your break-even number, the point at which revenue for a given period equals expenses. To do the calculation requires knowing total expenses and gross profit percentage, which is determined by dividing gross profit by sales.
Here’s how to do the math: If Mr. Smith’s monthly expenses were $20,000 and if his gross profit percentage was 50 percent, he would divide $20,000 by 50 percent to get a break-even number of $40,000 — the amount he had to sell to break even.