Sustaining Business Newsletter

Understanding Financials
By Craig Bohnsack

Publication Date: April, 2011

Business owners often gauge their business' success by the balance in the checking account or how busy they are without analyzing their business regularly to see if it's truly profitable.  Businesses are not like your car.  There is no "check engine" light that illuminates when there is a problem - businesses simply stop functioning.

TREND ANALYSIS

Looking at past years' performance helps establish a baseline for measurement.  A trend analysis examines any fluctuations from revenues, cost of goods sold (COGS) and expenses - not only looking at the dollar amounts, but also at percentages.  For example, an owner might notice that his COGS over time have been averaging 60% and expenses at 30% of revenues, resulting in a 10% net income.  If the first quarter of 2011 indicates the COGS were 60% while expenses increased to 45%, this could be a recipe for an end of the year loss if not immediately addressed.  While there could be several explanations for this situation, the owner or manager might not have been aware the business was slowly losing money every month if he was not carefully analyzing the financials along the way.

Another example:  a business checking account experienced a big swell in one month - a great thing, right?  It depends.  If another business partner had drawn on the line of credit and that was the true source of the money in checking account, it might not be such a great thing.  If the dollars weren't derived from profit but from the use of credit, it could be misleading.  Alternatively, a business owner might be very proud if her accounts receivable were reduced by half.  Further review might find the change was due to the accountant having written that amount off as bad debt.  The owner may not realize she needs to improve her collection process and might actually give up collecting on the past due accounts.

BUSINESS PLANS AND BUDGETING

Operating budgets are also very important.  Imagine a pilot without a flight plan.  Maybe he'll get where he's going safely and maybe he'll run out of fuel before he gets there.  Perhaps he just flies around looking for a nice place to land.  Whatever the outcome, a pilot without a fight plan is like a business owner without a business plan and a budget.  Business owners and managers need to ask themselves, "What does success look like?"   Once that vision is defined, a plan can be developed that will help them achieve that success.  Business plans must include budgetary details about where revenues will come from and how they will be spent.  Surprisingly, we see businesses all the time that operate without budgets or they want to increase revenues and profits by doing the same things they've always done.  It rarely works out.

Larger businesses usually have a board of directors and possibly a chief financial officer who bring their collective experience to bear on the operation of the business.  Smaller companies usually can't afford that luxury and may find themselves lost among their financial data.  Occasionally, those larger companies even ask an outside firm for a second opinion - recognizing that a different set of eyes might identify a different set of challenges and opportunities.  Hendrickson Business Advisors has a great deal of collective experience in reviewing financials - contact us to help you work through developing, understanding, and controlling your business's future.