[Editor’s Note: From time to time, SelfMade likes to partner with guest bloggers to bring you a wide variety of business information on topics of interest to the self-employed. The following post is written by Bill Hettinger, Ph.D. , and the author of the book pictured below. We hope you enjoy!]
If you're like many small business owners, you would rather go to the dentist than read your business’ financial statements. The common reaction to financial statements is that they're boring, they're intimidating, I don’t understand the content, and if I were to look at them, where would I start?
Instead of putting those financial statements in the filing cabinet, let's look at a few things that you can easily review each month that will tell you how your business is doing.
1. Profits. When your accountant or bookkeeper prepares your monthly financial statements, the first thing you should look at is the profits of the business. Profits can be found on the profit and loss statement (a.k.a. the income statement).
What should you look for when looking at the profits? Most important, you should look to see that the profit number is positive. If the profit is positive, you're making money. If the profit is negative, you're not making money.
The next thing you should do is to compare the profit for this month to the profit for last month. Is the profit increasing or decreasing? Increasing profits are good, decreasing profits are not so good. It's also good to look your profit trends over few months so you have an idea of which way the business is heading. A general trend of increasing profits is good. A general trend of decreasing profits is a sign that something might be wrong.
2. Cash flow. The next item to consider is your cash flow. Take a look at your cash flow report and look for two things: first that the business had a positive cash flow for the period; and second that the cash flow came from the operations of the business itself and not from financing activity such as bank loans or additional investment from the owner. If the owner is continually investing additional money in the business, or the business is continually borrowing, and business is not generating sufficient cash from operations, this is a red flag that the business may not be sustainable long-term.
3. Margins. The next items to review are your margins. The gross profit of a business is calculated by subtracting cost of goods sold from revenue. If you divide gross profit by revenue, you get the gross margin. The gross margin is the amount of money the business makes from each sale.
As you did when looking at the profits, you should compare the gross margins from this month to the gross margins from prior months. If the gross margin is stable or increasing, that's great and the businesses on sound footing, however if the gross margin is declining, the business is not making as much from each sale as it did in the past and this is an early warning of potential future profit issues.
Read more tips from Bill in his book, Finance Without Fear.
About the Author:
Bill Hettinger, Ph.D. is an internationally known consultant, educator, and thought leader who has trained numerous students, business owners, and managers in finance, entrepreneurship and small-business creation.