By Rayanna Anderson, MBA
I spend considerable time counseling small business owners and entrepreneurs in Springfield, all of whom cherish a dream of business success.
However, the bar for success in a new business is high.
According to the United States Census Bureau, over half of all new businesses fail within the first five years. Experts agree that a leading cause of such failure is that business owners often do not understand their financial statements, and consequently, fail to manage their cash flow.
How can you avoid becoming one of the statistics?
Making it in today’s business world requires more than looking at the bottom line on income statements. It involves understanding and interpreting what the income statement, balance sheet and some key financial ratios really mean. It involves using that information to make informed business decisions.
The first step is to acquire a good knowledge of what the reports are really telling you. The income statement, also called a “P&L,” profit and loss statement, or an income and expense report, is your best starting point. It is a summary of revenue and expenses that have occurred over a period of time, and is required for tax purposes. Information from the income statement can be used to make better-informed decisions about your company’s pricing, margin maintenance and expense control.
But how do you know if your numbers are good or bad? Compare dollar amounts from year to year, or from month to month. Many companies have seasonal sales cycles and the relevant comparison is how you did over that period of time compared with the same period in prior years. For example, if you sell Christmas candles, you would want to compare your sales after Thanksgiving through the end of the year to that period of time every year, with the goal of being more profitable every year. Additionally, you would want to compare your results with others in the same industry. Your best resource for that is a trade association for your business. When that is not available, other resources are available at most libraries or the Missouri State University Small Business and Technology Development Center.
Second is the balance sheet, which shows what the company owns (its assets), what the company owes (its liabilities) and the difference between them (its owner equity, also called “net assets”). It gives the financial condition of the company at a point in time.
And just like the income statement, if you really want to see a true picture of how you are doing, you need to look at trends over time, and compare your numbers to companies within the same industry.
To truly be able to use financial information to make better business decisions — particularly with respect to cash flow — we need to look at numbers in relationship to each other.
Ratios tell you about the efficiency of your operation. Some especially useful ratios to consider are: the current ratio, which impacts your ability to pay your bills; days receivable ratio, which tells you the average number of days customers are taking to pay you; days payable ratio, which tells you the average number of days you are taking to pay your suppliers; and inventory turnover ratio, which tells you the number of times inventory is sold and replaced over a year, a measure of how well you are managing your inventory.
These ratios are all key to your company’s success and indeed, in staying in business. If your customers take too long to pay you, or if you are taking too long to pay your bills yourself, your business will not survive. Staying on top of the numbers and managing the issues when problems first arrive is key to your success.
For further information on understanding financial statements or financial ratios, call the MSU Small Business & Technology Development Centers at 417-837-2617.
This article appeared in the March 16, 2014 issue of the Springfield News-Leader. It is available online here.
Rayanna Anderson, MBA, is director of the Small Business Technology Development Center and the Management Development Institute at Missouri State University’s E-Factory. Anderson writes about issues she sees regularly in her consulting with small businesses in Springfield and the state of Missouri. Email: randerson@missouristate.edu.