You might think that your company's financial statements are difficult to misread. After all, the revenue and expense numbers that they list are plain and unambiguous, right? The truth, though, is that business owners and managers misconstrue their financial reports all the time. In fact, some companies actually fail for this very reason alone.
Indeed, such misunderstandings are likely more common now than ever before because software programs such as QuickBooks make it so easy for entrepreneurs to quickly churn out financial statements. They no longer need to fully comprehend what they're doing because the software automates it all for them. However, automation without understanding can create significant problems.
Therefore, it makes sense for even the shrewdest businessperson to hire professional accounting and bookkeeping services. Trained professionals will be able to tell you when your business is in danger of collapse even when you appear to be raking in healthy profits. They can warn you when your expenses are about to exceed the amount of money that you're taking in. Plus, they can use their deep knowledge of complicated tax regulations to ensure that your company receives every tax break and opportunity to which it is entitled.
Not least, when you have professional accountants tending to your financial affairs, it gives you more time to do those things that you probably love most: inspiring your employees, interacting with your customers, and preparing exciting ventures for the future.
Even with great bookkeepers and controllers at your company's side, though, it's important to have a basic grasp of general accounting principles. They'll always help you to view your organization's financial outlook as clearly as possible and to make plans accordingly.
1. Keep Your Break-Even Number in Mind
It comes as no surprise that the field of accounting involves plenty of numbers. However, at any given moment, there's really just one number that you need to see for a sense of how well your company is faring financially. It's the break-even number. In essence, your break-even number will tell you if your revenue streams have surpassed your expenses during a certain period.
Let's say that you own an ice cream parlor and that you want to know your break-even number for the past year. Let's also stipulate that your establishment's annual expenses total $100,000 and that your gross profit percentage ― the proportion of your sales that counts as profit ― amounts to 40 percent. In that case, all you'd have to do is divide $100,000 by 40 percent. That would give you an annual break-even number of $250,000. You would thus need to sell $250,000 every year in order to stay afloat. If you knew that you were selling less than $250,000 annually, you'd have to take action. You could reduce your expenses, for example, or you might raise your prices.
You could also calculate break-even numbers for each month, each week, and even each day. The beauty of this statistic is that it's always accurate. It can't be fudged or misinterpreted to make it seem as though a business is performing better than it really is.
2. Don't Think of Loans as Assets
Imagine that you run a small but popular pizza restaurant. One day, you decide to open another eatery--after all, the first business is booming! To finance the construction of that restaurant, you borrow a hefty sum of money from a bank. Consequently, on your next financial statement, it will seem as though your business has recently brought in much more cash than it actually has. That's because the money that your bank loaned you will show up as revenue. Of course, in reality, you'll have to return all of that money with interest at some point.
3. Go Easy on New Expenses
One vital strategy is to try to avoid dramatic spending increases whenever your revenue goes up. For instance, say that you opened a grocery store a short time ago, and it's quickly become a big success. With all of that money suddenly flowing in, it's natural and understandable that you'd want to grow your earnings even more by making investments. You might wish to buy attractive new signs, billboard advertisements, extra land for your parking lot, and so on.
However, it's much wiser to make such purchases carefully and incrementally. Choose a certain expenditure and wait to see how well it performs. If it brings in considerable revenue, consider another modest new expenditure. That way you'll have a monetary cushion in case one of your experiments doesn't work out. By contrast, if you let a rosy financial statement make you giddy, it can easily lead to purchases that turn out to be destructive.
4. Never Count Your Receivables Before They Hatch
Another common problem is that small business owners will rely too much on their receivables. Your account receivables are amounts of money that clients owe you. For example, pretend that you own a company that installs windows. You've just serviced a local business and that establishment now owes you $10,000. In accounting, such a receivable is classified as an asset. For that reason, your financial records will indicate that your company took in $10,000 as soon as you completed that window installation.
But what happens if the owner of that business never actually pays you the $10,000? What if he or she were to go out of business or flee the country, stiffing creditors in the process? Business owners always have to worry about customers who can't or won't pay up. Of course, you can try to go to court to retrieve that receivable, but court expenses are often costly, and even then there are times when customers simply do not pay.
With all of that in mind, it's important to enact measures to rein in your receivables. That is you might want to insist that all of your clients pay ahead of time or you might set strict limits on how much a customer can purchase from you on credit. In addition, you could tighten up your collections methods and diligently remind clients about their debts. Finally, make sure you have legal options to leverage if you need them.