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Business Owner Report Card
Diane Kennedy, CPA
The course Understanding Financial Statements teaches you
how to read your standard financial statements: Balance
Sheet, Profit & Loss and Statement of Cash Flows. This
knowledge helps you determine how your business is doing.
But how are you doing as the owner? This section is about
the measurements that assess how well you are using the
assets you have.
A great book about this is, “The Ultimate Blueprint” by
Keith Cunningham. To learn more about being a better
business manager, pick it up.
Effectiveness
How effective are you at converting your assets into sales?
The effectiveness ratio will give you that answer.
But let’s start with another question. Who has the better
business: The guy with $100 in assets or the guy with
$100,000 in assets?
Well, if you’re measuring how effective he is as a manager,
the answer is “it depends.”
If the sales are exactly the same between the $100 business
and the $100,000 business, then the smaller asset value is
better.
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The effectiveness ratio is calculated by dividing the gross
sales by the total assets.
Gross sales / Total assets
If the total asset amount is more, than your ratio will be
lower.
But let’s look at this without all the math. If you have a lot of
assets, we want to see how good you are at turning that into
cash. The first step of that is sales.
If you are able to run a lean ship, without a lot tied up into
assets, you have the ability to scale much faster. If it takes
$100,000 to make $100,000, you’ll have to save up or borrow
to get another location started. However, if it takes $100,
than you could start a new location every month.
Assets include cash, inventory, machinery, equipment and
furniture. If you dump a lot of money into inventory that
just sits there, your assets are higher. That means your
effectiveness ratio goes down. Makes sense. You have a lot
of inefficiencies there. You could also build up useless assets
by buying fancy office furniture. I’ve seen that happen
before when companies start growing. The money goes into
things that don’t help the business, just the owner’s ego.
Stay efficient and check this ratio at least quarterly to make
sure you are properly managing your assets. When we’re
done with the other ratios, I’ll go through suggestions on
what you can do to improve this ratio.
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Efficiency
How efficiently are you running your business? How much
net profit do you have available to you, after the expenses
are paid from those sales?
This is where I take a departure from conventional
accounting. As a Tax Strategist, I want you to take advantage
of all of the tax breaks you can. If there is a legal benefit that
you can take from a company for something you would
normally buy with after tax dollars, I’m going to encourage
you to have the business take the deduction.
But it’s not really a necessary expense for the business. It’s a
legal tax deduction, but not really vital for a lean business.
That’s where I like to see three categories on a financial
statement. These are:
Direct – Cost of good sold (COGS) and other expenses
directly related to fulfilling on the sale
Indirect – Other costs that are associated with your business,
but not directly related to the sale. For example, this would
be your office rent, computer, desk and the like. These
expenses are also called “General & Administrative” and “G
& A”.
Benefit – These are expenses that are benefits for you. It
would include your salary, health insurance, car and other
benefits that your business pays for.
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Your Profit & Loss would then look like:
Sales
COGS
Gross Profit
$ xxx,xxx
( xx,xxx)
$ xx,xxx
G&A
Owner Benefits
( xx,xxx)
( xx,xxx)
Net Income/Loss
$ x,xxx
For purposes of this calculation, use the Net Income and add
back the Owner Benefits. This gives you the true Net Income
for the company, without the Owner Benefits. As a Tax
Strategist, I want you to take all the deductions you can. But
for purposes of determining the true income of your
business, the Owner Benefits just distort.
The efficiency ratio is:
Income / Sales = Efficiency Ratio
You can break that down even further:
Gross Profit / Sales = Gross Margin
As your business grows, you won’t be able to keep all of the
numbers in your head. Use these ratios to make sure
everything is staying in line, systems are working as they
should and you have people you can trust in place.
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Productivity
None of this means anything if you don’t have cash. The
final ratio uses Operating Cash Flow as a component. This
comes from the Statement of Cash Flows, discussed in the
Understanding Financial Statements course.
Operating Cash Flow / Profit = Productivity
How can you make more money in your business? Most
people will answer that they need more sales, but when you
consider the average small business has 90% cost, the answer
is actually different.
If you simply reduce your expenses by 11%, you will double
your profits.
This is a strategy that you can do in 2 months or less,
whereas a plan to double your sales could take 6 months or
more.
Watch your bottomline.
If you really want to increase sales, there are five strategies:
Increase number of customers/clients
Increase the frequency of sales to your customers/clients
Increase the price
Increase the transaction size
Upsell
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To decrease your expenses, examine carefully these problem
areas:
Cost of goods sold (direct costs)
Marketing
General & Administration
Taxes
Business & Personal Non-essentials
To increase your cash flow:
#1: Reduce the receivable days
Set expectation with your clients
Enforce the agreement
Be proactive early
Reward early pay with less expensive perks
Take credit cards and Pay Pal
#2: Reduce the inventory days
Order just in time
Take all available discounts
Sell obsolete quickly
#3: Increase the payable days
Negotiate longer periods to pay
Take longer to pay (avoiding penalties)
Pay bills once per week
Next Steps
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Why go to all this trouble? You have a choice with your
business. You can treat it like a job. If you don’t do it, it
doesn’t get done. You can make a good living, but you’re the
one who has to do the work. It’s a tiring way of life.
Or you can be a successful business owner. That means you
manage the business, working on the business, not in the
business.
As you grow your business, you need to be able to keep an
eye on what is working and what is not.
One more thing to consider: The best way to learn about the
future is to examine the past. That’s the point of comparing
financial statements by period using ratios instead of dollars.
None of this works without accurate and timely financial
statements. If you don’t currently have a system to produce
a monthly financial statement, put that in place soon.
Your business will thank you.
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