As a Virtual Chief Financial Officer (Virtual CFO), I regularly consult with many business owners and finance managers. Some are new…many are very experienced. And many are clearly unaware of their business’ actual financial position.
Many of them don’t prepare or receive accurate and prompt financial reports. I am staggered that many go several months without ever seeing a profit and loss report. And many are oblivious to what their numbers are saying when they do get them. Then there are those who focus on the wrong numbers.
I do not seek to undermine anyone with my comments. I acknowledge that many have received little or no formal training on how to read their financial statements.
However, if you operate or manage a business, you must know how to read and interpret the numbers. And it’s much more than understanding the numbers in the profit and loss statement. You mustn’t be seduced by the numbers given to you on fancy spreadsheets.
Look at your bank account. It’s dollars that are paid into it – not percentages, ratios or numbers.
I recently advised an owner to turn down a contract that they had just been successfully awarded. “No way, it’s worth two-hundred thousand dollars” he screamed. I contested that he would be wise to reject contracts with margins that could potentially cripple his business.
“Our revenues will grow by 35% and what we lose on margins we’ll recover by increased volumes” he confidently continued. In my opinion, his argument is flawed. If you’re making a loss on selling one widget, it’s often a dead certainty that selling more lead to losing even more money. Poor cash flow management often induces the death knell before poor margins will.
As a Virtual CFO, I’m regularly called on to comment on the latest financial reports in board meetings. The board of directors salivate at a profit and loss report that shows a healthy profit. They look at me dismayed when I ask to see the balance sheet, cash flow report and current debtors listing.
Their confidence quickly disappears as I highlight the company has an empty bank account and a long list of creditors who haven’t been paid yet. Cash owed to staff, government and secured lenders further weakens their mood.
Let’s look at it differently.
Sales are not the best indicator when it comes to measuring a business’ success or health. Not all sales are created equal. As a Virtual CFO I review the cost of sales (costs associated with generating the sales) and margins. I acknowledge that growing sales and the customer base is important. But focusing on sales at the expense of everything else is potentially disastrous. I know businesses with $10m turnover, $1m debt, and make $100k profit. I also know businesses with $2m turnover, have $500k in the bank, are debt free and enjoy annual profits of $300k. I’m guessing you know which owner has more sleepless nights.
Profit is a more dependable gauge of a business’ financial health, although it can also be very misleading as well. Your profit and loss report will offer you a picture of your business’ financial performance over time and may also identify if your operating model is sound. However, the “profit” shown on a profit and loss report may be an illusion…albeit temporary. You can’t pay staff wages, your tax bill or your creditors by waving your financial statements at them. They seek cash, not accounting statements.
Cash is your friend, not profit. Ensure that every new initiative or “deal” is approved only after their cash implications are known. Most business meeting focus on sales and “paper” profit. Yes, I know they are important, but as a Virtual CFO, I encourage you to ask yourself:
* How much cash is in the bank?
* How much do we owe and how much are we owed?
* How will this new initiative affect our cash flows?
Remember, cash is your business’ oxygen. When it runs out, you’re going to notice as you gasp for more. As the saying goes “revenue is vanity, profit is sanity, but cash is reality”. To ensure that you’re focusing on the numbers that really matter, talk to your Virtual CFO.