I’m Scott Lacy, a small business owner and consultant for ASBTDC. My background is in corporate finance and small business ownership, so I’m able to help our clients with financial projections, cash flow management, and business budgeting in addition to general consulting.
My main objectives are to help clients understand their businesses from a financial perspective, enable them to make decisions informed by data, reduce their risk, and set their businesses up for manageable growth toward their goals.
Below, I’ve outlined several topics that I encourage all my clients to explore to gain a solid foundational understanding of their finances at this point in their business lifecycle. These financial need-to-knows are essential to guiding your day-to-day decisions and long-term goals.
First, don’t worry if numbers and finance aren’t your favorite management responsibilities. Most entrepreneurs don’t go into business because they are passionate about book keeping, and as a result, most experience what is called the entrepreneur’s dilemma.
The entrepreneur’s dilemma occurs when a person transforms their hobby or passion into a business, but, with growth, must spend an increasing amount of time running the business, therefore diminishing their time spent on the original passion.
This secondary type of work as an entrepreneur includes duties like managing human resources, marketing, and finance.
At this stage, it’s sink or swim. If someone isn’t naturally business savvy or interested in data and numbers, the interest that sparked the business idea becomes less and less enjoyable.
So, my goal is to help entrepreneurs at this stage to run their business in a manageable way that allows them to preserve energy for their original passion.
Success is the ability to maximize the margin between effort and enjoyment.
Don’t let the word finance scare you away from turning your passion into a career. Financial management is a learned skill and takes discipline and direction. I’m here to help you learn and practice that skill. Determining answers to the questions below and defining the metrics in this article is your first exercise.
1. Goals: What’s your why?
Set goals, as they will give you target markers and give you something to strive for.
- Why did you start your business?
- Monthly income or lifestyle?
- Passive income?
- Legacy for children?
- Do you have any financial responsibility to partners?
- What are your sales targets?
2. Records and Bookkeeping: Know your medical history
Reliable decision-making is making accurate, informed decisions due to timely information. You need to keep good records for decisions down the line.
Reasons to bookkeep:
- Getting loans or investments?
- Banks/investors are going to ask for financial statements
- Selling your business?
- Buyer will want books to know the worth of your business
- Is there money leaking out the back door?
- This is often caught by detailed records & consistent reviews.
- Evaluating your goals?
- Records allow you to financially measure how well you are hitting benchmarks and achieving goals Government compliance or filing taxes?
Methods and tools:
- Self, CPA, or Hybrid?
- Do it Yourself: Keeping track of your own records using pen & paper or using Excel
- CPA: Certified public accountant who has the necessary schooling and licensing that will help you do your taxes in a way that is compliant with the government.
- Hybrid: Doing a combination of keeping track of your own records then passing on information to a CPA to file taxes.
- Online, Pen & Paper, Spreadsheets, or Software?
- Online: Using a website/software such as QuickBooks or Bench
- Pen & paper: An efficient way for smaller businesses to keep track of their records
- Spreadsheets: Using Excel or Google Sheets, great ways to compare/analyze your records
- Software: QuickBooks or Bench, allow you to know your budgets and records in real time
Bookkeeping Process & Frequency:
- You need to automate or gather data
- Automate data collection using point of sale (POS) system
- Gather data using bank accounts, etc.
- The weekly accounting process:
- Categorize
- Record
- Balance
- Close your books according to the IRS
3. Budgets and Forecasting: Are you getting to your destination?
A budget or forecast is an estimate of expenses and income over a set period of time.
Why Budget?
- Effective capital allocation for maximum return
- Gain control over spending
- Evaluate managers and product lines
- Empower and train employees with key information
How?
- Remember your goals and priorities (refer to the work you did above)
- Look at your historical sales and spending
- Estimate/project your future spending and sales
- Write down your budgets (expenses) and projections (revenues):
- Revenue – Expenses = Profit
- Adjust your spending in light of results, goals, and priorities
4. Profit vs. Cash flow: Show me the money!
Profit and cash are NOT the same thing!
- Profit = Revenue – Expenses
- Gross profit margin = (Revenue – Cost of Goods Sold)/ Revenue
- Net profit margin = Net income / Revenue
- Recording income and expenses: Cash method vs. Accrual method
- Cash Method: Revenue/Expense is recorded once Cash is received/disbursed
- Accrual Method: Revenue/Expense is recorded when it is incurred
How to know if you’re profitable and cash flow positive:
Profitability lies in the Income Statement:
- Formula: Revenue – COGS = Gross profit – Operating expenses = Net profit
- Total your revenues (money coming in), then subtract your COGS (what it costs to make or sell your product/service). You will get your gross profit (represents the profit you make before you take out your operating expenses/taxes). Subtract your operating expenses (your fixed and variable expenses, what you spend each month or annually), and you will get your net profit (your bottom line).
Cash lies in the Statement of Cash Flows:
- Net income + Net cash from Operating + Net cash from Investing + Net cash from Financing = Net cash increase or decrease
- Find your net income (comes directly from your income statement), then add back your net cash from your operating activities. Then add back your net cash from your investing activities, and lastly add back your net cash from your financing activities. This will give you your net cash increase or decrease (which tells you if you can afford to pay your bills).
Key Takeaways:
- Profitability is a measure of operational effectiveness, not the ability to pay your bills
- Cash is the lifeblood of your business
- Accrual based businesses must keep careful track of their cashflows
- Positive cash flow is more important than profitability
5. Tools and Gauges for your Financial Dashboard: Flying the Plane
Measurements you need to track:
- Break-even is when:
- Total expenses = Total revenues
- Fixed costs/(sales price per unit – variable costs per unit)
- Budgets to have:
- Actual
- Projected
- Historical
- Sales
- Gross profit margin: (Revenue – COGS) / Revenue
- Net profit margin: Revenue – COGS – operating expenses & ITD/revenue
- Month’s cash reserves: How well you can pay your bills (banks use this) (3-6months on hand)
- Formula: Total cash/average monthly expenses
- Quick ratio: Another formula showing how healthy you are and if you can pay your bills
- Formula: (Current assets – inventory)/ current liabilities
- Sales trend
- Accounts receivable average collection time
- Net cash increase or decrease
Writing down your business’s goals, keeping records, budgeting, looking at your profits and cash flows, and gauging where you are across the metrics in this article will allow you to make better informed decisions, have a better understanding of where your business stands, and better allocate capital to the struggling and thriving areas of your business.
Finance doesn’t have to be the pain point for your small business.
If you need further help going through the steps in this article, attend one of our upcoming financial workshops or schedule a consultation with me or another ASBTDC team member.