I’m going to let you in on a secret: The best businesses — those that really boost the wealth and happiness of the business owner — are not built on intuition or luck.
As much as we would like to think that great entrepreneurs have some kind of special gift, the best among us simply know how to create and use meaningful financial reporting, and use it to make decisions that improve our businesses. With a good eye on the numbers and some careful analysis, any business owner can see what is going right and what is going wrong.
But running a business “by the numbers” means that your financial reports needs be built on the 3 Rs: reliability, readability, and regularity:
- Reliable: To get credible and meaningful output, you’ve got to fix your accounting data and clean up any input errors.
- Readable: To give management something that’s easy to understand, your chart of accounts must clearly reflect your operations — particularly in which costs you attribute to cost of goods.
- Regular: To see important trends and changes, you must maintain the books at least weekly, AND forecast cash and funding needs.
Let’s look at each R, and what it takes to implement in your business:
Make it reliable
Make your financial reporting reliable by cleaning up your accounting data. It’s obvious that you can’t understand the true performance of your business without reliable data, but it’s amazing how many businesses are running with bad numbers in their financial reporting. There are a few telltale signs of bad data:
- System notifications. This seems obvious, but if you are receiving system notifications like “Balance sheet out of balance” or “Data problems,” you need to fix these database errors. Most accounting systems include a process for verifying the file structure and rebuilding the data if a problem is found. In Sage50 (Peachtree), try “Purging” the file of old data; for QuickBooks, run a regular “Rebuild”… or call a Pro Advisor for support. (This is also a good time to backup your files before you push the button!)
- Negative balances. If you have asset or liability accounts with negative balances, this is a sure sign of missing transactions. How would you know? Print a balance sheet. The only accounts on the balance sheet that should show a negative value are “Depreciation” accounts. (If you have had significant losses or are taking a lot of cash out of the business, you may also have a negative in “Total Equity” or “Owners Distributions” accounts.) Any other negative number on the balance sheet means that you have recorded transactions incorrectly.
- Missing money. Watch out for a few common expenses that are often overlooked. If you own a building, a car, or any kind of equipment (such as your PC) then you should be booking depreciation expenses regularly. Likewise, if you have any kind of loan, your books should reflect interest expense. Too often I see income statements that ignore these two key numbers. And boy, can they make a big difference to how you look at your business!
Make it readable
Can a stranger look at your income statement and tell you the story of your company’s performance? If you’ve organized your chart of accounts well, almost anyone should be able to tell you a lot about your business. To make the P&L speak to you, the chart of accounts must be properly organized.
I don’t mean “proper” in the sense that it meets international accounting standards; I mean only that it truly reflects what’s going on in your company. Does your P&L describe the company in the same way you do? If you say, “We make and sell cars, boats, and airplanes,” is there an income line for each of those categories of products? Can you spot exactly what it costs you to make a car? A boat? An airplane? Try reading your P&L out loud. If you can’t tell the story, get to work on a better chart of accounts.
While you are thinking about how to organize your income and expenses, pay special attention to how you record your product costs. (In manufacturing, this includes raw materials, direct labor, and machine burden; in retail it should include cost of goods, shipping, discounts or penalties, and any other direct cost you can identify.)
Why? You can’t set pricing if you don’t know your true costs.
I’m willing to bet that at least one of your products or services is not profitable. Do you know which one it is? You spend a lot of time establishing a pricing strategy, but if your books aren’t organized so you can easily see your profitability by product line — and make sound pricing decisions — you may be losing money without even knowing it. (There are some good reasons for selling a product at a loss — you can probably name at least three — but you should do so knowingly.)
Finally, organize your chart of accounts to improve management understanding. This is a widespread problem, and it’s easy to understand the cause. Your chart of accounts was probably developed early in the evolution of your business and has either changed very little, or has grown out of control ever since!
Sure, your CPA is happy with any organization so long as he can identify income and expenses for tax purposes. But as a leader, you need management information. You want to know the profitability of your business by segment at the very least. For your business, a “segment” could be product lines, geographic divisions, or business units. For you to be able to get useful reports — and make correct management decisions — your chart of accounts needs to be properly organized.
So take control and beat it into shape. Any financial consultant or CPA should be able to help you. Start with a discussion of the business operations, and then make sure the accounts reflect the operational reality.
Do it regularly
Devote the necessary resources to have accurate and up-to-date financial reporting at all times. To be helpful, your data has to be timely, so reconcile your bank accounts at least weekly, and “close” the books monthly. And don’t assign the task to just anyone. Get a knowledgeable accountant (or at least a very experienced bookkeeper), and then ask an outside advisor to review and QC your books at least monthly.
This third “R” is perhaps the most important: having a regular schedule is key to keeping the numbers readable and reliable.
Finally, have an up-to-date cash forecast and a plan for emergency funding. To be successful, your business must be profitable — but that’s not enough. The road to ruin is littered with profitable businesses that ran out of cash. Your business must be cash-positive (or you have to plan for funding your cash-negative operation). Start by really understanding your cash cycle and work to optimize it. Then develop a useful cash plan and a system to maintain it.
Use the results!
Next time you find yourself making an important business decision, reflect on the three Rs of financial reporting. Are you making vital decisions based on flawed reporting?
Implementing the three Rs is a great first step to the kind of financial discipline and reporting that will help you make better decisions — and create the wealth and happiness you deserve from your company.
This article was written by David Worrell from Forbes.