Understanding the Financials of Your Business

Skye Leist
July 12, 2011

Hello. My name is Rich and I dont understand my businesss financial statements.

Sounds like an introduction at a 12-step program, doesnt it? Im not sure how I stayed in business for 14 years and counting with such a tenuous grasp on the finances of running a business.

Im easily stumped by such accounting questions as:

Why is it a debit when a client gives us a down payment?
Are we cash or accrual?
Does it really impact our business if clients pay us lateas long as they pay us?

It was because of these questions (and others) that I attended Financials for the Math Challenged yesterday, presented by Don Gooding of the Maine Center for Enterprise Development. Although not all of my questions were answered, it did start me down the path of getting a better grasp on the numbers of running flyte. If you struggle with understanding the concepts of your own financials, read on.

Let me start by saying that I may not have gotten everything correct here. My goal for writing this post was as much to help me make sense of it as it was to share this information with you. Ive found by writing things down it helps cement the ideas in my own head, plus it exposes holes and questions that I wouldnt have otherwise noticed.

In the workshop we talked about accrual based accounting vs. cash based accounting.

Whats the difference between accrual and cash based accounting you ask? Cash based measures income when its received, while accrual measures income when its been earned. For example, if youre cash based you measure that down payment when you get it; if youre accrual based you dont recognize it until youve done the work that the down payment was meant to cover. Likewise, cash basis claims deductions when they are paid, accrual claim them when they are incurred. In the workshop we focused on accrual basis accounting.

All the money that comes in and out of your business needs to be accounted for. (File under duh.) The money is organized into different categories, or buckets. Don Gooding suggested that businesses may have created too many buckets for their own good, and suggests the following:

Revenue - the money you get from selling stuff (products, services, subscriptions, ad revenues, retainers, etc.)
Cost of Goods Sold - expenses directly associated with making the stuff you sell (and generally the more you sell, the more your COGS go up; materials used, shipping costs, direct labor, shrinkagenothing to do with George Constanzasales taxes, etc.)
Sales & Marketing money spent to generate revenue (ad costs, website expenses, sales commissions, brochures & flyers, the labor of your marketing and sales team, etc.)
General & Administrative rent, repairs & maintenance, telephone & utilities, etc., and surprisingly the owners salary, as we often do so many little things around the company)
Product development investments in future revenue streams

My takeaway from this and the conversation is that these buckets are not set in stone; different businesses may have more or fewer buckets, may categorize certain expenses or income in different buckets, etc. Don was just suggesting this as a starting point and as a way to get a better grasp on the money coming in and out of our own businesses. Personally, I found that these were helpful ways of thinking about our own spending habits. We also saw that small changes in any one of these buckets can have a huge impact on profitability.

Most people are visual, and will comprehend a pie chart easier than a spreadsheet. You may want to export your buckets out of QuickBooks and into Excel so that you can create pie charts of your monthly accounting. Or create a bar chart so you can track specific buckets over time.

Sometimes this big picture view can be more helpful, especially if numbers arent your thing.

Another important thing to track was your accounts receivable and how long its taking you to get paid. This has a huge impact on your cash flow, which can make or break a small company. If its taking longer for you to get paid by clients you may need to talk to them about getting paid on time. You can also stop paying early andtake longer to pay your bills to improve your cash flow (although if you are delinquent in your payments that can have other negative implications.)

I definitely felt like I could sit through the presentation again and get more out of it. Id like to sit down with my books with an eye towards cleaning up some of my buckets and focus on those first. After I feel comfortable with that I might dig down into different buckets to try and improve our cash flow and financial well being.

For example, what type of work is most profitable for us? Is the web design, the SEO, or our social media consulting? Or something more random, like our email newsletter design or Facebook webinars?

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