Measuring up to financials

4 financial tools every business should use

See a business within the industry that has closed its doors permanently and you will undoubtedly have people commenting, “I guess they just couldn’t make a go of it.” Or, “Obviously they couldn’t make a profit at what they were doing, so they went out of business.”

There is a certain degree of validity to what is being said. But at the same time, there is an inference that the business being discussed was not profitable. Surprisingly, statistics do not agree with this statement, as over half of the businesses in North America that have closed were actually profitable at the time they closed. If they were making money, why did they close? This concept does not seem to make sense.

Financial understanding has always been one of the courses offered to owners and upper level management, for the lack of financial understanding is one of the two major faults we see in businesses. (The other major fault is lack of a commitment to continual staff education.)

Within each business there should be four financial tools in place. They are a budget, a cashflow chart, an inventory-control system, and financial statements (balance sheet and profit-and-loss statement). Each of these items plays a major part in assisting a business in increasing profits, quickly resolving problems, and taking advantage of opportunities.

Let’s take a quick look at each of them—and their contents—so you can confirm that you are getting the most opportunities to profit from your financial information.

Most businesses receive a financial statement every month. It traditionally consists of two documents. One is a profit and-loss statement (also referred to as income statement). This tells the business how much profit (or loss) has occurred in the last accounting period, which is traditionally the last calendar month. 

The related document is the balance sheet that reflects the overall health of the business. It changes monthly as a result of the income statement as well as when the business has purchased or sold assets, and when there are changes to the accounts payable and accounts receivable. If the section of the balance sheet that reflects the ownership position (often the “stockholder’s equity”) increases from month to month, then the business is most likely becoming stronger.

The two fatal mistakes that frequently occur with these two documents is a failure to produce the information in a timely manner after the conclusion of each month and the failure to read, understand, and make decisions for changes within the business.

The second document we mentioned was a budget. Just as a person might create a budget for his or her family, he or she should have a budget that does much the same task for the business.

Imagine a person who makes a commitment to lose 25 pounds beginning on New Year’s Day.

If this person waits until November 1 to check his weight and finds that he has lost only 5 pounds, he faces the sizable challenge of losing 20 more pounds in only 60 days—and they are 60 days of the most challenging opportunities to eat.

Instead, if this person were to check his weight on February 1 and find that he had gained 2 pounds, he would have an advantage. One is that he has quickly found that his strategy for weight loss is not working and that he needs to make changes. Two is that he now has over 330 days to get rid of 27 pounds. The person in the second scenario is probably more likely to obtain the goal.

The budget for a business is much like the weight situation. Created and printed, the budget tells you each and every month how you are doing with regard to your goal. Failure to create, understand, and manage with the balance sheet is a serious mistake for most businesses.

The cashflow chart works very well with the budget. In creating a cashflow chart, the numbers utilized would most likely come from a budget. The advantage of the cashflow chart over the budget is that the cashflow chart tells a person if there will be sufficient cash on hand to fuel the business plans for the coming months. Created properly, a cashflow chart will tell you how much inventory and cash will be in the business for each of the next 12 months! Imagine knowing today what your inventory levels and cash position will be a year from now!

Businesses that utilize a cashflow chart are able to accurately see well in advance the opportunities as well as the challenges and take the necessary steps to be proactive to them.

The fourth, and an often-underutilized tool, is a method of inventory control. Too often, someone in management or ownership looks at the financial statements; and upon seeing the amount of inventory in the business, exclaims with a degree of shock that he or she now knows where all of the money is for the business. 

An “open-to-buy” system is very good with regard to the numbers and inventory levels being correct. Eliminating surprises when inventory counts are verified is crucial to the success of a business in today’s competitive atmosphere.

Any of these four tools that becomes overlooked or underutilized can seriously damage, or even be fatal, to a business— regardless of who your customers are or what area of the industry you work within.

If you have concerns about any of these four, one solution is to visit the public library to locate books on these tools. You can also enroll in an entry-level accounting class that places an emphasis on these topics.

You—and your business—will be glad you did.

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