What Story Are Your Financials Telling?
I have always had a burning desire to know how my business measured up to industry peers. Were we above average, middle of the pack or a bottom feeder?
Years ago, while moderating a workshop at KBIS, the workshop presenter invited me to join an industry-specific peer group that he was facilitating. Sensing this is where I could gain some perspective about my business, I accepted the invitation.
My first meeting had me sitting around a boardroom table with owners of eight other kitchen and bath businesses from different geographical areas. The format was simple: sharing information, issues and challenges, and poring over each other’s financial statements.
I arrived at this meeting confident, perhaps even a bit cocky; I knew my numbers. The feeling didn’t last. My peers were starting to ask rapid-fire questions about the financials. I found myself struggling to provide satisfactory answers. Embarrassment and insecurity quickly replaced confidence.
That experience taught me several things. Primarily, I need to spend more time with the financials to understand the relationship between the numbers and the information revealed, and that most kitchen and bath dealers/owners don’t fully understand the importance of their financial statements. The latter is because most have grown up on the design and selling side of the business.
As a business owner, it’s critical to comprehend and own the financial side of the business; otherwise, you may never realize the company’s full income and profit potential. While accountants and bookkeepers play an essential role, it’s the role of owners to learn the meaning of these financial statements and determine what should be done to improve company performance.
So, a little primary education in this arena will set the stage for understanding the crucial values derived from knowing what your financial statements are saying about the state of your business.
The Difference in Financial Statements
Financial statements are divided into three categories: Income Statement (also known as a Profit and Loss Statement), Balance Sheet and a Cash Flow Statement.
An Income Statement measures your company’s financial performance in the current year. It’s measured by how much revenue (sales) has been recorded versus how many expenses have been incurred to generate that revenue level; the difference – revenue minus expenses – is called Net Profit.
A Balance Sheet measures your company’s cumulative performance since the inception of the business. It’s measured by how many assets you have acquired over these years minus the liabilities incurred in the process; the difference (Assets – Liabilities) is called Net Worth. The net worth is derived from several components: initial capital, retained earnings and the current year’s net profit, which is the common link between the Income Statement and the Balance Sheet in any given year.
Cash Flow Statements provide a summary of how cash enters and leaves the company. It measures how well a business manages its cash. Cash is king. Cash is the lifeblood of any business, and how well it’s being managed needs to be documented.
Cash and Accrual Accounting
There is a significant difference between cash and accrual accounting, and not knowing the difference and its impact on a business can lead to severe consequences. The main difference between the two types of accounting is when revenue and expenses are recognized and recorded.
Cash Accounting records revenue when cash is received. A 50% down payment on a newly signed kitchen would show up as revenue on the income statement. With no expenses to record yet, the financials could reveal a sizable net profit. The pitfall for this kind of accounting is that it might overstate the health of the business. Under this scenario, the company could be cash-rich, lulling the owner into a false illusion that the business is profitable when in reality, the business may be losing money.
Accrual Accounting recognizes and records revenue when it is earned. Revenue recognized upon delivery of a product or service aligns with the associated expenses and services provided.
The accrual method provides a more accurate picture of the business’s overall health by including all revenue when earned and all expenses when incurred. This more accurate financial data places an owner in a better position to make sound business decisions and limits the risk of overpaying taxes.
Managing by Percentages
Managing a business by reviewing and looking at strictly numbers can be challenging. It can be easy to overlook a change in revenue or an increase in expenses when focused primarily on the numbers – or, worse, not knowing what the numbers mean. It also makes it difficult to compare one financial statement to another or understand the changes occurring over time.
A more straightforward method to manage is inserting a column into a financial statement where any line item amount is expressed as a percentage of the overall net revenue. Total revenue is listed as 100%, and cost of goods, gross profit and all other line items are expressed as a percent of the total revenue. This method makes it easier to analyze the performance of a business over time and compare it with peers or industry benchmarks.
Benefits of Knowing Your Financials
Your financials tell a story about your business, what is occurring at the moment, and a telling tale about your organization’s history. It’s important to be adept in reading, interpreting and using your financial statements as a guide to making wise business decisions.
There are many benefits to being financially savvy. First, you can protect yourself from possible embezzlement. Placing all your trust in a bookkeeper without having financial know-how creates exposure that is often hard to overcome.
Second, you can better measure your financial performance against others in a group, identifying weaknesses where your business can improve. Third, you can ask better questions of professionals so you can secure better advice. Fourth, you can set more intelligent and realistic goals. Fifth, you can furnish more confident leadership, attracting and retaining quality personnel. And sixth, knowing the financials like you know the designing of kitchens can make you a lot more profit!
Commit to gain a deeper financial understanding of your business. Invest in yourself to learn the financials, and the story conveyed. Financial knowledge comes with reward – realizing the full profit potential of the business and leveraging it appropriately.
Dan Luck owns Bella Domicile in Madison, WI. He has been an SEN Member since 2002 and has led the SEN Leadership Team since 2018. Visit sendesigngroup/education for more information. Dan welcomes
questions and comments at [email protected].
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