Archives#financialanalysis Archives — C. Lynn Northrup, CPA, CPIM
We’ve just finished up paying our taxes for the year. Maybe you had to pay more than you wanted and had to scramble to come up with enough cash for the payment. You might have looked at the numbers and wondered why we didn’t do better. There could be lots of scenarios to the story.
Reality is that many businesses don’t really know how they are doing and wonder how they can do better. This is an all too familiar theme for most small businesses. It is essential for businesses to take time to consider their options.
Here’s some signals that maybe your business could use some help:
- Gross margins have decreased.
- You can’t identify your product margins.
- Profit margins are too low.
- Your cost structure is out of line with the competition.
- You’re borrowing too much.
- You have declining trends over the past few months.
Maybe you need a tune-up:
- Has income declined over the last three quarters/
- Are sales declining?
- Are you satisfied with your overall results?
- Do you have a plan to maintain your rate of growth?
Here’s some signs that things need to turn around:
- Are you starting to lose money?
- Do you have too much inventory?
- Can you recruit new help?
- Do you have too much debt?
- Do you know where you are making profits?
- By customer
- By product or service
- Have you lost business to competitors?
Crisis questions might include:
- Can you meet payroll?
- Will the bank lend you more money?
- Have good employees quit?
- Have vendors stopped shipping goods to you?
- Have you had time to think and strategize?
- Have any of your customers who don’t pay on time stopped ordering?
Maybe you just think your business should be doing better and you don’t know why. Whatever the reasons, there are things every business should and could be doing to make things better. My blog post on Biggest Business Problems explains and discusses these issues.
The first thing businesses should do is step back to reflect on what you have done and where you want to go. Businesses fail to engage in “Strategic Thinking” and they fail to effectively “measure their performance” on a regular basis.
These are what I call the Management Tools for Success that are critical for growing and increasing profitability. Business owners need to spend the time and effort to learn about accounting and measurement. In addition, they need to then learn how to apply these tools to making their business more successful.
My goal is to provide business owners with the knowledge and tools they need to be successful. Take advantage of my consulting experience which are offered as resources for businesses on a subscription basis and as toolkits and checklists which can be downloaded from my store.
A good way to get started is with The Guide to Strategic Thinking and The Strategic Thinking Toolkit and creating a plan for Profit Enhancement. The key is doing something rather than just thinking about it. So go make it happen.
I provide my small business clients with a road map to success by helping them solve problems. Having said that, here is what I think are the three biggest problems:
- Business Planning
- Financial Management
- Managing Business Processes
Based on my experience these are the areas where all businesses have issues. However, smaller businesses struggle more with them because they lack the necessary resources and expertise.
All businesses plan at some level but do a poor job of it. They fail to do it in the depth that’s required and don’t address the strategic elements needed for success. Planning takes patience and time to carefully pull together all the necessary components. Leaving out strategic and competitive analysis combined with strategic thinking is a recipe for failure.
All businesses, especially small business, should get help to coach them through the planning process. They could gain the benefit of skilled expertise and objective insight that will increase their sales and profits. Well conceived strategies make the difference between failure and success.
Financial management is another problem area. Accounting and finance is like a foreign language to most small business owners and yet it is one of the most critical components of building a successful business. Cash management and good performance measurement are often neglected or done poorly. Business owners should consider having a financial pro assist them in monitoring this data on a monthly basis.
Monthly diagnostic analysis is affordable using cloud-based tools and is money well spent. My approach is to track trends against goals for all the key financial indicators. This is a simple straightforward approach that most small business people can grasp. This process will take less than an hour each month and is a critical step to help keep the business on track toward achieving its goals.
Every business has processes that can be improved. Process improvement gets neglected because of the tendency to get caught up in day to day details. Objective assessments can quickly identify processes and areas for improvement. A skilled business coach can zoom in on problem areas overlooked by business owners who are too close to the action. Just having the support of an advisor can significantly improve profitability.
Narrowing small business problems down to the top three was a good challenge for me. It got me thinking about the multiplicity of problems facing small business. I think that addressing these top three will develop solutions for 80 percent of all small business problems.
This focusing process emphasized my conclusion that small business owners should seek help in dealing with these three problem areas. They need to overcome the resistance to spending money on a coach or a financial pro since it represents an investment in their successful business future.
If you can’t measure it, you can’t control it. If you can’t control it, you can’t manage it and improve it. Businesses are flooded with an overload of information and data. So what should we measure?
My approach to performance measurement is to keep it simple and focus on the indicators that matter the most. Measurements should be action oriented to help businesses make better decisions and at the right time. This requires an accounting and financial information system capable of providing the right information on a timely basis.
Measurement starts with a strategy, goals, and plans. Knowing where you are going and what’s needed to get there is critical. This is where most small businesses fail to do a good job. They need help with planning and making sense out of measurement. A good coach combined with CFO support can be a difference maker.
Metrics that matter should include:
- Cost of Goods Sold
- Gross Margin
- Quick Ratio
- Debt to Asset Ratio
- Days of Sales in Accounts Receivable
- Payroll/Number of Employees
Tracking trends on these top 10 metrics and comparing performance against forecast and goals is the key to small businesses survival and success.
All the above measurements matter, but cash is king. Cash starts with converting more sales leads into sales because it is critical to increasing cash flow. Once you make the sale, it’s time to get paid, and the faster the better. Since many businesses sell on terms of 30 days, closely monitoring accounts receivable and the number of days sales outstanding is one of the key components of cash conversion efficiency. The faster or fewer number of days sales outstanding, the better.
You need to purchase materials or goods that are recorded into inventory before converting them into sales. The more effectively you turn your inventory into sales by reducing cycle time is crucial. Your cash conversion is determined by combining the average number of days cash is tied up in accounts receivable plus the average days cash is held in inventory less the average number of days of payables. The fewer number of days contained in the cycle the better.
The faster your cycle time, the faster you will convert your sales into cash. A component in achieving faster cycle times is to reduce the number of days required to send out your sales invoices after goods have been shipped or services rendered.
Monitoring profit margins is another element of keeping your business healthy. Tracking the trend of sales, expenses, and cash using diagnostic dashboards is something every business should be doing on a monthly basis.
Virtual CFOs can be a big help to small businesses in measuring and monitoring performance because they know how to use cloud-based dashboard tools and charts to point out the areas where improvement is needed. They also understand the relationship between key measurements and how they impact performance. Having monthly performance measurement reviews should be a ritual for every business as they can represent the difference between success and failure.