Making sense of your statements
February 23, 2010
By Laura Aiken
Reviewing your financial statements can make your eyes glaze over
faster than a cop after a crook. All of that accounting lingo may as
well be spoken on Mars. We trust our accountants and bookkeepers to
translate the bottom line back into an earth tongue. But there are good
reasons to learn a new language and get a grip on what your financials
are telling you. You can make a profit and have no money or have cash
but no profit … it’s just hard to stay afloat in that boat for long.
Reviewing your financial statements can make your eyes glaze over faster than a cop after a crook. All of that accounting lingo may as well be spoken on Mars. We trust our accountants and bookkeepers to translate the bottom line back into an earth tongue. But there are good reasons to learn a new language and get a grip on what your financials are telling you. You can make a profit and have no money or have cash but no profit … it’s just hard to stay afloat in that boat for long.
“It’s really hard to tell where you’re going unless you know where you’ve been,” says Jacqueline Bernal, owner of Bernal Business Services Inc. Bernal is a professional bookkeeper with more than 25 years of experience in accounting and marketing as well as a keynote speaker at small business seminars through the government of Alberta’s Business Link information program. “Most small business owners have their core skills in their specialty – their product. Few people take the time to learn finances.”
However, if you are relying on a bi-annual sit-down with your accountant to look at what your numbers mean you may find your business in trouble that should have been curbed four months earlier. It’s crucial, particularly in the first few years of running your bakery or restaurant, to read and understand a financial snapshot of your store each month. Bernal advises looking at the results from that month in comparison to last month and at the same time period in the previous year.
Lori Schmaltz, the regional agri-business leader for Alberta at Meyers Norris Penny accounting firm, says some of the most successful businesses and biggest clients don’t ask, don’t understand and are ashamed to ask how to analyze the financial statements of the company.
“Leaving it all to the end when it may be too late [is a common mistake]. You want your accountant involved before the mess happens. Your accountant should be giving you advice on how to protect your assets in tough times,” says Schmaltz. Come to regard your accountant as a business advisor and develop an ongoing relationship.
Business owners also often don’t involve their accountant at the appropriate time, such as before they go to the bank for a loan instead of after, says Schmaltz, nor do they diligently attain proactive tax advice so they pay the least possible amount.
Leaning on your accountant and bookkeeper is important, but you are the decision-maker. The ability to see what the numbers mean and find the answers to your questions gives you better control and leaves you making more timely choices for your business.
Meyers Norris Penny has packaged a “financial fluency” guide that presents some basic financial statement concepts in a particularly understandable way. The document outlines three goals attached to three different reports: Sell your product for more than it costs to produce (income statement), get a return on investment (balance sheet) and maintain a good cash flow (cash flow statement).
Your income statement shows business activities monthly, quarterly and yearly. The balance sheet is a snapshot of your restaurant at a defined point in time. The cash flow statement is the link between the income statement and balance sheet. Within these three important documents, Meyers Norris Penny outlines three bottom lines. The income statement shows net profit, the balance sheet shows your return on assets, and the cash flow statement reveals the operating cash flow.
Bernal notes that these are the key figures you need to understand: sales, cost of goods sold, gross profit, operating costs, administration costs and net profit. If there’s a problem with any of those numbers, take the next step and delve into the details.
“It’s not enough just to read them,” says Bernal. “You need to understand them.”
Understanding starts in looking at the key ratios of analysis that will make the information do something useful for you, says Bernal. Your current ratio (current assets divided by current liabilities) tells you whether or not you can pay your bills. Your return on investment (ROI) is measured by net income divided by investment. Your operating expense ratio is your operating expense over gross sales. Your profit margin is determined by your net income divided by your gross sales. Bernal also advises graphing the following figures monthly: gross sales, gross profit, labour costs, operating expenses, administration expenses and net profit.
The book Financial Management 101: Get a Grip on Your Numbers, by Angie Mohr, outlines a few other useful ratios. If you want to know the long-term solvency of your business it’s important to examine your total debt ratio. This is calculated by dividing your total debt by your total assets. If you’re looking to figure out how long your pastry boxes are spending on your shelves, you would use the inventory turnover ratio. This is important to understanding the cost of goods stored in your bakery. Your inventory turnover is equal to the cost of goods sold, divided by the ending inventory. To determine how quickly you get paid, determine your receivables turnover by dividing your sales by accounts receivables. Vice versa, if you want to know how quickly you are paying your suppliers; look at your payables turnover, which is your cost of goods sold divided by accounts payable.
Helping yourself, your bookkeeper and your accountant
A Point of Sales system will definitely help simplify your numbers for you, says Schmaltz, particularly when it comes to profit margins and pricing products. On the flipside, a POS system may not be something you’re ready to invest in and it’s important to look at all options. Some owners opt to do the books themselves. If you want to go that route, Schmaltz suggests hiring a bookkeeper or accountant to set your software up specifically to your business and get you on the right track from day one. This may cost a little bit up front, but she says it will save you a lot in the long run.
“It’s amazing how many [people] don’t understand the terminology,” says Schmaltz. “They get deeper and deeper [in trouble]. It’s subtle, but it happens.”
Some businesses save money by learning how to do some of the data entry and coding themselves, says Bernal. How often you use a bookkeeper, if at all, comes down to personal choice, but improperly done books are of little use.
“People often ask when they should hire a bookkeeper,” says Bernal. “If you don’t have the patience, don’t know some basic tax laws, or make more money running your business than doing the paperwork, then it’s time to hire a bookkeeper. The data entry is very detailed and really takes a lot of patience to produce useful financial statements. If data entry is not done properly the financial statements are useless.”
Schmaltz sees a few common scenarios where small businesses run into trouble when they don’t have a good grip on their financials.
“Often I see quite small businesses taking too much money out and having a hard time dividing the company from the person. Growing too fast is also really difficult. You can outgrow your cash flow and not be prepared with the resources behind you — go to the bank before the bank comes to you.”
Bernal often sees business owners misusing what you can claim on your taxes. It’s the business owner’s responsibility to provide the information accurately. Accountants and bookkeepers are legally bound to report something they know is wrong. And while accountants are registered and have strict rules to which they must adhere, bookkeepers are not registered. Anyone can call themselves a bookkeeper, thus professional quality can vary and their legal responsibility is weak. Canada Revenue Agency is a great reason unto itself to make sure you know what you’re doing in the numbers department, because at the end of the day it’s you they will be looking for.
Ready, set, plan!
Learning the mother tongue of Mars will go light years towards preparing a budget, creating strategies, and getting your business to where you want it to be. In Mohr’s book she describes the business planning cycle as plan, control, grow, fine tune and plan again. What stage your business is at will determine what questions your financial statements need to answer for you. Growth can be the most exciting phase to focus on but can also be one of the largest causes of business failure.
“It is only after you have a good handle on your business’s operations, that you should focus on growth,” writes Mohr. “Many small businesses are so concerned right from the start about growing that they do not know what impact the growth is having on their business. Without a plan, new customers can suck a business dry, absorbing more resources than they are adding revenue.”
Without a doubt, there is much to learn when it comes to the finances of your business. Thankfully the resources are abundant. Don’t be shy about turning to your accountant or bookkeeper with what may seem like the silliest of questions. Check out seminars in your area, books in the library or association materials. Webinars are a growing trend and a time effective way to source information as well.
Now pour yourself a cup of coffee, pin those eyelids open and go find out whether your dollars make any sense! / BJ
Laura Aiken is the editor of Canadian Pizza Magazine.
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