September 18, 2019
It’s time to focus on the factors that drive the value of your company. The benefits are two-fold. If you pay attention to the factors that improve the cash flow of your business, you will make more money and secondly, someday when you decide to sell; your business will be worth more.
Think of a profit-building factor as merely a characteristic of your business that either reduces the risk associated with owning it or a component that enhances the prospect that the company will grow further in the future. Of course, the corollary is, the higher the risk, the less a buyer is prepared to pay. By identifying the profit drivers in your business and focusing on them, you can achieve the best growth results.
Over the next series of our monthly posts, we are going to focus on the different specific drivers that will add value to your business. These topics will include; Financial Performance, Recurring Revenue, Operating Systems, and so much more.
After all, valuation is not about determining what your business is worth; it is what that next guy is prepared to pay!
Profit Builder Factor #1 Financial Performance
Very few small business owners have an interest in accounting. But as everyone finds out, understanding the basics of accounting can be the difference between success and failure of your company. Understanding your financial statements and reviewing them at least once every month will help you improve and identify potential issues. It’s essential to know; how much income you generate each month, what you’re spending it on and what the gross profit margin is.
Another way to analyze your financial health and identify how it might be improved is by looking closely at your financial ratios. These performance indicators are vital to helping you evaluate the success of your efforts and determine where you need to make changes.
One of the top benefits of doing a business financial temperature check frequently is having the foresight to not waste time on areas that aren’t doing well. Don’t wait until the end of the year to see what’s not working; you could miss out on opportunities during the year. Check to see which areas generate you the most income and think of ways to do more of those tasks. Consider putting an end to certain services that take up a lot of your time but don’t make a lot of money.
Here are some of the four most important accounting reports for you to go over.
1. The Income Statement/Profit and Loss Statement
The profit and loss (P&L) report or Income Statement is a financial statement which summarizes the total income and expenses of a business in a specific period of time. A well-run bookkeeping operation includes details for where you spend and from where your money comes; this is the statement bankers, investors, or purchasers will flip to first when they’re reviewing your business.
Business owners should look at this report at least monthly. This statement helps monitor the health of your company by comparing numbers during specific time segments of years or previous months. This should tell you what’s working well, what isn’t, and help you focus on the most profitable parts of the business.
2. Balance Sheet
The balance sheet captures the value of your assets (things you own), liabilities (what you owe), and net assets (the difference between assets and liabilities). It shows you how much money you would have leftover if you sold all your assets and paid off all your debts (i.e., it also shows ‘owner’s equity’). This statement shows your organization’s financial position at a single moment in time, so read your balance sheet regularly and compare it with previous years to gain an accurate picture. The more familiar you are with your organization’s reports, the better you’ll become at spotting good news and bad news, and knowing how to address potential problems.
3. Accounts Receivable and Accounts Payable Reports
The Accounts Receivable (A/R) aging report is a critical tool for managing your business. An aging report is useful because it gives you a snapshot of the money that is outstanding and due to you by your customers. It also helps you identify customers that are falling behind on their payments – a clear sign of an underlying problem. Note that slow payments do not always indicate financial issues; it could mean a possible dispute or misunderstanding. Many companies use this report when planning collections calls and when trying to forecast their cash flow.
Your Accounts Payable (A/P) aging report gives you an overview of what your business owes for supplies, inventory, and services. Regularly reviewing this report gives you a chance to monitor expenses, oversee payments, pinpoint potential trouble spots early, and identify areas where you could implement new strategies and improve your business’s cash flow. This report can be especially handy when it comes to managing a tight cash flow because it assists you in determining which of your vendors should be paid immediately and which can wait a bit longer. It also makes it easy to see upcoming obligations, which can aid you in the process of planning your payments. Ultimately, using an accounts payable aging report properly can help you increase your company’s financial stability through budgeting and prepare it for future growth.
Ratios are used to make comparisons between different aspects of a company’s performance or how the company is performing in a particular industry or region. They reveal fundamental information such as whether you have accumulated too much debt, stockpiled too much inventory or are not collecting receivables fast enough. Ideally, you should review your ratios on a monthly basis to keep on top of changing trends in your company. Although there are different terms for different ratios, they fall into four basic categories; Profitability, Cash Flow and Liquidity, Risk and Return and Stock Turnover and Sales.
Non-financial ratios can also be relevant to your business, as they can highlight issues that may not show up on the balance sheet. Staff turnover and client satisfaction are examples of non-financial factors you may want to examine.
Evcor Business Valuations can recommend the most suitable ratios for your business and show you how to produce reports to calculate and monitor them. Once you have started to analyze the figures produced by your financial ratios, you can use them to benchmark your business; this will help you assess productivity by comparing your performance to other companies in your industry.
The time spent running and reviewing all of these reports regularly is generally time well spent.