Managing your Numbers as a Business Owner
Back in day, when the small business owner ran his shop, he handled the five business management skills by himself: strategic management, people management, operations, sales & marketing and most importantly, financial management. To some extent he would delegate tasks but most of the responsibility to grow the business would be shouldered by him. In today’s world, change comes quicker and poor financial management is the leading cause of business failure among SMEs. The key is relying on what your numbers tell you before making a decision. But to do that you would have to first understand your numbers, and by that I mean accounting.
Shark Tank is a great testament to why this is so important. It’s a show about aspiring entrepreneurs who make business presentations to a panel of five veteran investors, called "sharks". Depending on how they like the business pitch, the "sharks" will then choose whether or not to invest as business partners -- I've seen a single investor pump in a million U.S. dollars for just a stake in the company. In one episode, I saw a feisty lady who captured the sharks' attention with her product. But while pitching her numbers she fumbled a couple of details and got called out by one of the sharks. In the end, she went home without a single investor. My take away from that is, numbers are the heartbeat to your business and you MUST know your numbers. You’re not a good entrepreneur if you don’t know very much about the financial side of your business.
If you dislike accounting, you’re not alone. It is a task some would describe as boring, repetitive and in some cases can be perceived to be of not much use to the business owner. But let me assure you, it is not. Book-keeping is the art of managing financial documents and recording transactions in accordance with regulatory requirements. Sounds lame, but your business will eventually fail without it.
As a business owner, no matter how much you hate bookkeeping, you’ve got to do it. Every business entity has to keep a detailed record of its financial activities in order to comply with tax laws. Even if you hire a bookkeeper or accountant to keep the numbers in order, understanding the fundamentals of accounting can help you make better choices for your business, so remember to ask questions and use Google.
To build or maintain a successful business, every owner should understand these four basic accounting concepts:
1. Cash-Flow
Profitable businesses have failed because of poor cash-flow management. The key is being organised. Use a spreadsheet and plan out your daily, monthly and yearly expenses. Depending on your type of business, manage your receivables and payables along with budgeting for recurring bills. Only paying bills when they are due can ensure that your business has enough in the bank in case of a rainy day or something unexpected happens. By knowing how much money you can commit to spending right now, you can make better strategic decisions for the business.
2. Understand your key ratios
Track your break-even point (BEP) as a round number. You need to know this number and have an indication of how far away it is at any time. It’s just simple math, but is often overlooked by business owners. It can be defined in many ways, I would suggest you Google it. I think of it as the amount of sales I need to cover my operational costs for the month, to arrive at zero profit/loss. Once again, this would help in decision making. For example, if you haven’t reached your break-even point this month, you can focus on increasing sales or decreasing expenses. When you know what that secret number is and can stay focused on it, you’ll be better equipped to make wise choices about your bottom line.
Always know what your profit margin is, as a percentage. Your profit margin, or sometimes referred to as gross profit margin can be defined as the difference between a products’ selling price and its cost of production, in proportion to its selling price. So basically your gross profit divided by sales.
This really informative picture by AccountingCorner.org shows us how to calculate the gross profit margin ratio. Having a high profit margin is great, but more important should be focusing on sustainability and consistency. Lower margins indicate higher operational risk but also increase barriers of entry for new entrants in the market. You need to know what your margin is and strive to increase it without jeopardizing your quality whilst still staying competitive in the market.
3. Understand your expenses
While it’s often true that you must spend money to make money, many business owners don’t have a handle on exactly how much they’re spending—or whether those expenses are even necessary. To build a strong income statement (and a strong company), you must understand how much you’re spending each month, and on what and why. It’s easy to get carried away when you’re in the black.
For instance, if you’re spending money on advertising or marketing, you should be asking every customer how he or she found you. Keep track of how many customers are finding you as a result of each ad or event, and make sure the return justifies your investment. Cost of acquiring new customers should be tracked within each marketing stream. If you’re spending money on social media or other Internet campaigns, tools like Google Analytics can help you determine whether your money is being spent wisely.
4. File your supporting documents properly
Documents such as payment vouchers and sales invoices which are issued need to be sequentially pre-numbered. Supporting documents such as supplier invoices, expense claims, receipts and bills need to be filed in an organised manner and retained for seven years before being stored in cold-storage. These documents are the basis of the financial statements of your business. They are confidential and will be the evidence you need should the Inland Revenue Board of Malaysia (IRB) come knocking. Remember, keep your books neat and your house in order. Always hope for the best but be prepared for the worst.