Finance 101 for Small to Medium-Sized Business Owners
“Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.” – – – Warren Buffett
Most of the CEOs I work with tell me they value my financial expertise. With this in mind, I wanted to offer some thoughts on company financial controls (principally relative to financial information) that I know will be of help to all those who own or manage companies.
It may come as a surprise to learn that even though my early professional training and most of my career have centered on my role as a CPA, I was not engaged fully in the nitty-gritty of helping clients gain control over their finances until I became a business coach. It is this experience of working side-by-side (and “in the weeds” in many cases) with CEOs, that has deepened my experience and expanded my role as a trusted financial advisor.
This edition of my blog offers key insights and focuses on some of the most important things to keep in mind when managing the finances of small to medium-sized companies. Readers who meet one or more of the following criteria will derive the most value from this edition of my blog:
- Your business is incorporated; it is not a lifestyle endeavor or hobby, and you want to run it the way a successful company should be run;
- You are principally invested in the business and you lend your talents and training in service to the corporation on a consistent basis;
- You need outside financing, principally bank loans, from time to time, to finance growth and capital investments and/or
- You have an intention to sell the business some day.
With that said, here are my key points on Finance 101:
- Pay yourself a fair salary: If you are providing services to the corporation, make sure you pay yourself a salary. Otherwise, your financial numbers won’t reflect reality. Also, if you don’t pay yourself a salary for the value you provide to the company, how do you know the company is profitable? I presume your services are valuable. You spend time working on the company’s behalf, and I know many of you spend a great deal of time working at or for the company. No one would invest as you do without receiving sufficient compensation. There is a cost for the work you do. If you could not fill the role or roles yourself, you would have to pay someone (or perhaps more than one person) to provide these services. I understand many start-ups don’t necessarily think this way. However, even in the case of start-ups where salaries for the principal owners/investors are not established, it is a good practice to place a chit in the company’s accounts payable folder to remind you to catch up when things start cranking up.
- Insist on timely and accurate information each month: If you are waiting until April to get January’s numbers, how can you possibly stay on top of your financial situation? The patient (your company) could be on life support before you find out. Your financial statements properly stated, classified and described, are like buying an insurance policy to keep you on top of where your business is going.
- Think about your return on investment (ROI): If you own the company, this means you are an investor. This is a different role than that of an employee. You have likely invested not only your money – but time and effort – to get your business started or to keep it going. You are entitled to ROI; otherwise you might as well invest your money in a savings account, government bond or the stock market. By the way, according to Joan Magretta (Understanding Michael Porter: The Essential Guide to Competition and Strategy), “In the United States, from 1992 to 2006, the average company earned about 14.9 percent return on equity (earnings before interest and taxes divided by average invested capital less excess cash).” Many small to medium-sized business owners don’t know or they don’t care about a return on their investment, and this is a mistake. Why? Any equity investment has inherent risk and you should be compensated for the risk you take.
- Quantify and understand the difference between Fixed and Variable Costs: Business owners need to understand the meanings of Fixed Cost and Variable Cost. Why? You need to know your spending parameters and you need to maintain a focus on your Gross Margin Percentage. Sometimes Fixed Costs are called Indirect Costs or overhead. They are generally fixed within certain limits, but it is my experience that they increase over time. Fixed Costs are the expenses you absolutely need to control. Variable Costs are called Direct Costs or Production Costs. These are generally dependent on the level of company activity required to produce your sales dollars. The best way to control Variable Costs is to become more efficient in producing and delivering your goods and/or services. Variable Costs determine your Gross Margin (Sales minus Variable Costs). Why is Gross Margin important? Your Gross Profit Margin has to cover your Fixed Costs. If your Gross Margin does not cover your Fixed Costs then the business will lose money.
- Create and review monthly Cash Flow Statements: Every business owner who has receivables, inventory and/or payables should look at producing a Cash Flow Statement every month. Why?
- Cash is always king. You have more flexibility when you have more cash.
- Knowing where your cash comes from and where it’s going is critical. An Income Statement alone will not be sufficient in explaining how your cash is accumulated – or drained.
- The Cash Flow Statement provides insight. It tells you a lot about how you are managing the growth of company assets and liabilities.
- Increasing receivables and increasing inventory adds more risk to the company.
- Increasing payables eventually will be a cash drain when they are paid off.
- The Cash Flow Statement will also tell you how much money you are investing in capital expenditures.
- Pay your taxes and file your tax returns on a timely basis: Don’t play the tax lottery with the taxing authorities. One excuse that some business owners use is that they don’t have the cash. Most qualified tax advisors will recommend you file even if you can’t pay, but you should discuss this issue with a competent professional who has knowledge and facts about your particular tax situation. You don’t want the IRS controlling your decisions if you are in tax arrears. Stay current on your tax bills!
In my next blog I will cover how you can generate useful information from financial data to properly assess your business for future improvement, and for dressing up the Piggy before taking it to the market (i.e., to see your banker for a loan, or in advance of identifying prospective buyers, if selling is your ultimate objective).
Copyright 2013 © John J. Trakselis, Chicago CEO Coaching
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