Do you let your accountant handle all your numbers? You might want to rethink that approach. Having done business with thousands of small businesses over decades I can safely say that, if there was ONE thing that shocks me, it would be the number of directors that don’t understand financial reporting and their actual financial position.
It’s not just new businesses, some have been trading for many years and are clueless about the difference between ‘Revenue’ and ‘Gross Profit’. Seriously! Many companies don’t produce timely, let alone accurate, financial reports. An absence of a Profit & Loss statement (P&L) is akin to trying to run a business with the lights off. While others may have financial reporting sorted, they lack the basic knowledge to interpret the information that matters. You can have all the financial reporting in the world, but if you’re focussing on all the wrong information, what’s the point?
Look, I’m not putting anyone down here, even with proper training financial management is something that takes years to master fully. I can tell you that from personal experience as even now I’m always learning new things. It’s merely a fact that many management level ‘executives’ have zero financial training or even any authentic experience.
Directors must understand financial reporting
Now, if there’s one takeaway from the time you’ve invested in this article, it’s that you need to understand your financial reporting. If you have anything to do with owning or managing a business, it’s simply essential that you can do more than read the bottom line of the P&L. You can’t deposit fancy formulas, graphs or the latest ratios into your bank account. Dollars, however, you can.
“Revenue is Vanity. Profit is Sanity. Cash is Reality.”
In practice, this means that it’s not always a good idea to celebrate that shiny new ‘HUGE’ contract. That’s right. Believe it or not, it may be doing more harm than help for your business. I get it, it’s easy to get excited over big numbers, but do these top-line numbers put you in a better position?
It’s vital to consider associated margins, payment terms and any other factors that will impact the underlying business. How many times have you heard (or used!) the line,
“What we lose on margin, we’ll make up on volume”?
While this might sound reasonable, it doesn’t work. If you are losing money on a deal, increasing the volume of that deal means you will lose more money, and at a faster rate.
The P&L is just one part of the financial picture
It’s a scenario I’ve seen countless times. Businesses present to me with a great set of P&L’s, with some impressive numbers. Of course, I, and lenders, are also interested in their balance sheet, bank statements, debtors aging reports and most importantly, the statement of cash flows.
Their enthusiasm dissipates when they’re shown the reality that the numbers they were so confident with are just not going to cut it. Their near-empty bank account and the endless list of creditors to pay confirm the case. Unfortunately, GST, BAS and Super commitments are not going to disappear anytime soon magically – they’re real, and you need to take them into account.
The best measures of business health
Let’s break down the financial waterfall, so we understand where the water ends up…
Revenue is the most basic measure of business performance. Yes, it’s the amount you’re expecting to receive. But that’s it. And not all revenue is equal. How much did it cost to generate those sales? How likely is it you’ll get paid? While it’s integral to your business to grow customers and sales, you also need to consider these questions, or it can be deadly for your business. Ignorance is NOT bliss. Would you rather be generating $10m in revenue with debt and no profits OR $1m in sales with a substantial operating margin and cash in the bank? The choice should be clear.
Profit is a lot more insightful than revenue in terms of business health. But it’s certainly not perfect. Profit takes into account different sets of costs incurred to earn revenue. While useful as part of a detailed P&L for telling us if the business model makes financial sense, it’s still not real. You can’t pay your staff with a big green number on a piece of paper. You need something more tangible…
Cash. It makes sure you don’t crash, so focus on improving your stash. Cash is real. You can pay your staff, debts and yourself with it. You can shower in it too if you wish. Cash is the life pool where all the other metrics, ratios and margins land. From now on, I challenge you to only agree to a deal once you know, with a high degree of certainty, what the cash implications for your business will be.
So remember, cash is like a clear nose. Except much more important. It’s probably not the main motivator in your life, but when you lose it, you’ll sure miss being able to breathe.
Until next time,