End Goal: Understand how to do a financial analysis #

As your business progresses you will want to take the time to analyze your financials.  In the beginning you should be doing this on a weekly basis, but as you grow and your time becomes more limited set aside some time each month to give your financials a proper review.  The longer your business is open the more data you will have and the better the information.

Accounting and Financial Statements: #

The first step for financial analysis is to make sure that your books are in order and your financial statements are accurate.  If you are working with a bookkeeper or an accountant you should request that they send you monthly financial statements.  If you are doing the books yourself, you should take the time each month to reconcile and close the books from the previous month.  You must have a good Profit & Loss and Balance Sheet in order to gain any insight from a financial analysis

Revenue: #

Top line of your Profit and Loss, this number is the first thing a business should analyze.

1. Growth over time – You always want to make sure your revenue is increasing.  Analyze your sales month by month and year by year to make sure you are tending upwards overall.
2. Sales Trends – You may be able to identify some trends in your sales over time.  Are some days better than others?  Are some months better?  Understanding when your sales are coming in is very important to plan your budget and particularly understand how best to spend your advertising dollars.
3. Best and Worst Sellers – If your business offers multiple products or services, you will want to analyze what your best and worst products are.  Using information from the feedback loop you should be able to identify why some things are selling better than others.  Can you improve some of worse products or is it worth cutting them all together?  How can you improve or expand upon some of your best selling products?
4. Pricing – Prices change over time, usually trending upwards with inflation, but your business may be losing money if it is charging too high a price.  Again, using feedback loop you should be able to determine how your customers feel about your prices.  Can you charge less and gain enough volume to ultimately end up with more profit?  Could you charge more and even with a drop in overall customers still end up with more?
   1. Don’t undervalue yourself – An important note is to not undervalue your product or service.  You may be profitable but its possible you are leaving money on the table.  Do not undervalue yourself or your products.

Expenses: #

This is the second thing a business should be analyzing on a regular basis.

1. Budgeting – Always be updating your budget as you are progressing through your business.  You want to be aware of all upcoming expenses and making sure your business is generating enough revenue to cover the expenses.
   1. Note: Budgeting does not mean limiting your expenses.  Say this again, just because you establish a budget does not mean you are fully limiting yourself to how much you allow yourself to spend.  If you want to have a $10,000 a month office party budget that is your decision, just make sure your revenue is covering it.
   2. Note 2: Do not think the budget is set in stone.  The budget should be a guideline not an immovable wall.  If you go a little over your office budget that is ok, just make sure you update your budget to what is needed and that your revenue can cover it.
2. Extraordinary or Yearly Expenses – Plan ahead for any extraordinary expenses or yearly expenses.  Most businesses will have some expenses that only hit once a year, like insurance for example.  You do not want to be caught unaware on these expenses.
3. Repair and Replacement – Equipment, even a computer, will eventually need repaired or completely replaced.  Do not forget about these costs when analyzing your expenses.
   1. Assets have a useful life and at the end of that you will need to replace them.
4. Reducing Costs – While analyzing your expenses, look for ways to reduce costs in every category.  There are only two ways to improve profitability, increase revenue and reduce expenses.  As you progress in your business, don’t be afraid to look out for other vendors that can reduce expenses.

Shrinkage: #

Theft and loss is a reality for any business.  You can do everything possible to eliminate it but it is impossible to be 100% successful.  There are many types of shrinkage that a business may experience.

1. Shoplifting – This is a real threat to small businesses, especially in certain states that have raised the felony limit on shoplifting charges.  Many large retailers are leaving those states due to losses from shoplifting.  While these large retailers can suffer these losses, shoplifting can destroy a small business.  Pay close attention to your security measures and do inventory counts on a regular basis to make sure as little inventory as possible is lost.
   1. Nothing is worth risking your life.  Do not put yourself in harm’s way to stop shoplifting.  
2. Vendor Theft – Whether intentionally malicious or just a simple mistake, your vendors may steal from you.  You want to double check all deliveries and invoices from your vendors.  If you have your accounting and budgeting all set, it should be relatively easy to discover any mistakes.
3. Employee Theft – As much as we hope our employees are honest and hardworking, there are some who will take advantage of businesses.  Whether the employee is straight out stealing inventory, mismanaging funds, admin/accounting errors, or just general laziness the results are the same, a loss to your business.  While you may not have the time to double check your employees work, you should be able to catch things if you have good systems in place and good analysis.
   1. Wage Theft – This is a hot button issue with some employers.  You as the boss want to get the most out of your employees.  The harder they work, the better your business does.  Some employees will steal time from you by adding hours on to their timeclock, so you definitely want to double check their time as best as possible.  But as we discussed before, have realistic expectations of your employees.  They are not the owner and do not care as much about your business as you do.  Taking a quick personal call in an emergency or using the restroom is not wage theft.  Spending several hours on the phone with a friend or hiding out in the bathroom for several hours is wage theft.  Be realistic in your expectations and your policies.
4. Administrative/Accounting Errors – The number one killer of small businesses is mismanagement, it has brought down more than one business.  Owners have a lot hats to wear, and a simple miscommunication with a customer or vendor, or a decimal in the wrong place can cost the business a lot of money.  It is important to set aside time to analyze everything to make sure the systems you formed in previous steps are working and not leading to losses.
5. Unpaid Invoices – Sometimes a customer or client will just refuse to pay.  Whether they can’t because of their own mismanagement, or they are deliberately trying to get one over on you, it is a reality that at some point you will not get paid.  You can send all kind of invoices, threats, small claims court, or even sue them and you may still not get paid.  It is a reality of doing business.  Learn to listen to your gut and don’t work with people who aren’t going to pay you.

Pay attention to your balance sheet: #

It is sometimes easy to forget the balance sheet as an important financial statement.  Much of our time will be spent tracking sales and managing expenses, but remember from a cash flow standpoint, revenue and expenses only tell half the story.  You need to set some time aside each month to review your balance sheet.  Be sure you understand your assets and liabilities and how it affects your cash flow.

Financial Equations: #

There are many equations used to evaluate your business.  These are a few examples.  Use these quick formulas and track what they are over time so you can tell if your business is becoming healthier or if you are slipping somewhere.

1. Gross Profit Margin – Revenue – COGS / Revenue.    We made an estimate of what our Gross Profit Margin would be in a previous phase.  If lower than expected, our COGS could be too high and we need to evaluate whether or not this is sustainable.
2. Net Profit Margin – Revenue – COGS – Operating Expenses / Revenue.  Again, we made an estimate of what our Net Profit Margin would be in a previous phase.  If it is higher than we estimated then we are doing great, but if it is lower than we estimated we need to analyze why.  Maybe we are not yet breaking even, our revenue is not covering our operating expenses.  Maybe our expenses are higher than expected.  It is not enough to just know our margins, we need to know why.
3. Return on Investment – Net Income/Total Capital Invested.  This number gives us some insight into whether our investment into the business has been worth the effort.  This number will change over time as you increase net income so do not let it be a deterrent.  This number shows us the return we are getting on the money we invested.
4. Debt Ration – Total Debt / Total Assets.  This number shows us the extent of our financial leverage.  The proper ratio varies widely across industries and you may even find that your ratio is over 1 meaning you have more debt than assets.  This is not necessarily bad, but it is something we want to monitor over time.  Ideally in every industry this number would decrease over time as our business increases and profits are used to pay down debts.  If it is increasing it means that we are taking on more liabilities and the business may not be sustainable.
5. EBITDA – Earnings before interest, taxes, depreciation and amortization.  This number is most commonly used in place of net income.  It is much more closely related to cash flow that net income.  (Note: Maybe just use a basic definition from Investopedia or something)