Know Your Numbers
If you're a typical entrepreneur, you likely have the confidence, intelligence and ambition to implement and execute your business plan. And if you have all those qualities--plus one more essential ingredient--then you have an excellent shot at business success. The problem is, this one critical ingredient often gets the least attention. So what is this all-important ingredient? Having a complete understanding of the numbers that drive your business.
Entrepreneurs are, by nature, focused and driven. They're focused on the next product and the next sale, yet when asked what last month's revenues were, or what accounts receivable are today, they may only have a foggy notion at best--even though the financials are the tools that help manage successful business ventures over the long haul.
For example, consider the emerging company with sales growing at 10 to 15 percent every month. The company is profitable, but never seems to have enough cash. A common error in this situation is to continue ignoring the numbers, and ultimately the business fails because it's strangled for cash.
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But the informed business owner with an eye on the financials can see that if sales are slowed and the collection of receivables is stepped up, then cash flow will magically increase. This allows the business to pay suppliers and vendors promptly and get working capital back to appropriate levels.
So what are the most important numbers for every emerging business owner to know? Keep your eyes on these numbers to best manage the financial side of your business:
- Working capital. Working capital is the capital you have available to work with today. This is determined by subtracting current liabilities from current assets. A rule of thumb says you should have $1.50 to $2 of current assets for every $1 of current liabilities.
- Revenues. Know your sales on a monthly, quarterly and year-to-date basis. Compare these to your plan to see if you are behind or ahead.
- Gross profit. Revenues less the direct costs of producing your product is your gross profit. In most cases, there should be 50 percent or more of your sales volume left over after you subtract your direct costs (cost of goods sold).
- Profit margin. Subtract the total of your general and administrative expenses from your gross profit, then divide that number by your sales. This number will tell you how profitable the business is. If the number is negative, you are losing money. Make sure the number is as good as or better than others in your industry. If the typical profit margin in your industry is 12 percent and yours is 5 percent, you are not managing your business as well as your competitors. Find out what you need to do to improve that margin.
- General and administrative expenses. There are typically three biggies over which the business owner has a great deal of control. Know these numbers, and be prepared to adjust them to the current business environment. They include:
- Compensation. This is often one of the largest expenses for any business. When business slows, you need to be positioned to reduce compensation quickly and decisively. This isn't always fun, but it's a decision that a business owner who knows the numbers must make.
- Marketing expenses. The largest marketing expense is often advertising. You should be able to turn up or slow down your sales by adjusting your advertising expenditures. If there does not appear to be a correlation between advertising and sales, then there may be something wrong with your advertising strategy. The important point is that if you do not compare your advertising expenses and sales, how will you know the effectiveness of your advertising?
- Research and development. R&D effectiveness is not as easy to quantify as advertising. However, the savvy manager sets a budget based on anticipated costs necessary to achieve a certain goal. Be certain to periodically measure your progress by comparing the amount spent with the proximity to the goal. Like compensation and marketing, this is a variable number that must be monitored and adjusted quickly to meet current needs.
Entrepreneurs who know their numbers have a tremendous advantage over those who do not. The financials tell a story--and understanding the story behind your numbers can be one of the most important ingredients for long-term success.
Bill Fiduccia is a founding partner of BizPlanIt, a professional business planning consulting firm that helps early-stage, emerging-growth and established companies prepare clear, concise and compelling business plans that get results.