Goal: Get Your Finances in Order
Get on Track with Financial Tracking
Your business can’t grow—not to mention survive—unless your finances are healthy and sound. Getting Your Finances in order is crucial.
Don’t limit your focus to the top of your profit and loss statement. The true test if your finances are healthy is your bottom line and cash flow.
Your company’s financial health is impacted by a number of factors. Some of these factors—cash flow, banking relationships, collection techniques—are often neglected until there’s trouble. Don’t wait until your company’s ailing to give these your attention.
To keep your finances healthy, practice good preventative medicine. Stay on top of all your critical numbers. The following worksheet will help you assess how well you’re currently doing with financial tracking.
Cash Is King: Perform a Cash Flow Projection
In good times and tough times, cash flow is more important than your profit and loss statement. Cash is what keeps you in business.
Cash flow projection can help you gauge your company’s health and can keep you from getting caught shorthanded if things suddenly tighten up. However, if you’re like most small business owners, you’re managing by your profit and loss statement, not your cash flow.
That’s fine most of the time, but sometimes, a positive P & L statement may lull you into a false sense of security. If you don’t have a positive cash flow, too, you’re headed for trouble! Unfortunately, many small businesses tend not to think much about their cash flow until there’s already a problem. That’s why it makes sense to routinely monitor cash flow and create cash flow projections, in good times and bad – in order to keep finances healthy.
There are a number of ways to make cash flow projections. (Remember, a future cash flow projection is nothing more than an educated guess of your projected revenues and gross margins. Projections are estimates, since actual incoming orders are unknown. However, you can and should know your fixed expenses, which must be paid each week or month.) One way to make projections is to base your revenues on your prior year’s financial history, making adjustments due to seasonality, potential accounts and current economic trends.
Take last year’s numbers, and then determine what’s different. Has your product line changed? Your prices? Did you gain or lose significant customers? Assign an estimated value to all these changes, and you can project how this year’s figures will stack up to last year’s. Or, if your company works by bid, you can use your bid history to project your future revenues. If you typically close 15% of outstanding bids, then you can determine what percentage of your outstanding bids will result in sales. You also have to factor in the time of bid awards.
Cash flow is nothing more than cash on hand plus cash coming in minus cash going out.
Learn to Breakout Your Expenses
Do you break out your expenses? Many small business owners don’t, and it’s their loss. Breaking out your expenses will give you all kinds of valuable information. For one thing, it will help you set pricing, identify just how deeply you can safely discount, and track your capacity utilization. In many ways, it will help you understand and run your business better. And when necessary, it will give you a starting point for reducing your expenses. You can’t start cutting until you know what you’re working with. Furthermore, it will allow you to determine your breakeven point—i.e., the volume of sales needed to keep your business afloat.
All of your expenses can be broken out, or divided, into one of four categories: fixed, variable, step variable and discretionary.
Here’s how they break down:
Fixed Expenses
Fixed expenses are those that remain consistent, no matter what your revenues are or your level of business activity. They include your rent, insurance, utilities, and full-time, salaried employees. The fixed expenses we are concerned with here are those you pay for with cash. (For example, depreciation and amortization are fixed expenses, but do not require a cash payout. Hourly activities could also be considered a fixed expense in certain situations.)
Variable Expenses
Variable expenses, on the other hand, include all those that fluctuate in proportion to production, including the cost of
goods sold, shipping costs, sales commissions, and direct hourly labor. When your revenues rise, your variable expenses do, too.
Step Variable Expenses
Step variable expenses are items that can be treated as a fixed expense, but will increase or can possibly be decreased
depending upon business activity. For example, you already have a customer service employee, and when business increases you may need to add another, but you will not immediately require full utilization of their activity.
Discretionary Expenses
Discretionary expenses are those that you do not have to incur in order to operate your business. These are costs you choose to incur, such as travel, entertainment, trade shows, and charitable donations. They will likely boost your business, but they aren’t critical to it. Obviously, when you’re in survival mode, it makes sense to put discretionary expenses on hold.
Keep in mind that some costs may be fixed for one company but variable for another. For example, your yellow pages listing is a fixed expense for the term of your contract, but pay-per-click advertising on Google or Yahoo may be considered variable.
How to Categorize Your Expenses
Now that we’ve defined the four categories, let’s get more specific. Here is a list of typical small business expenses, along with the suggested classifications for each of them.
Accounting: Normally a fixed expense. Tax returns are mandatory to file, and it is also necessary to do interim financial statements for lenders and management. However, some accounting activities can be eliminated or reduced by finding a less expensive source.
Administrative Salaries: Normally a fixed or step variable expense. But you must measure the capacity utilization of each administrative activity. This fixed expense can be reduced. Officer Salaries: Same as above, but officers are usually owners of the small business or people who have a major interest in continuation of the business. These expenses can also be reduced. (When there is pain, the owners must share in the pain and even have greater pain, because they have greater upside potential.)
Direct Labor: Considered a variable expense, provided direct labor payroll is directly related to the amount of production and output. Direct labor is normally paid by the hour. (If the producers are paid by salary, their salaries are only considered variable if the capacity utilization standard is maintained. Therefore, staff may have to be reduced to match demand.)
Advertising/Marketing: This is completely discretionary, even if their elimination will be detrimental to the Business.
Auto Expenses: The operating portion of auto expenses—i.e., fuel and maintenance–is variable, but if your equipment is leased, that portion is fixed.
Bank Charges: Fixed expense.
Donations: Discretionary expense.
Dues and Subscriptions: Discretionary expense.
Electricity (Power): Fixed expense; you need to keep the lights on. But a small portion can be considered variable due to increases or decreases in production requirements.
Employee Welfare: Discretionary expense.
Equipment Rental: Fixed expense.
Natural Gas (Heat): Fixed expense.
Insurance (Property and Casualty): Fixed expense, however you can elect to reduce coverage and partially self-insure to reduce these expenses.
Insurance (Group Health): This is treated as variable to your payroll expense, but in many situations it is actually Discretionary.
Insurance (Workers’ Compensation): Variable expense; it is related to your payroll.
Leased Equipment: Fixed expense.
Legal Expenses: Discretionary expense; each business has a choice of what legal activity it chooses to pursue.
Licenses and Permits: Fixed expense.
Maintenance Supplies: Fixed, variable, and discretionary! Maintenance is always required (fixed), but some is directly related to your amount of activity (variable). And sometimes you have a choice whether to proceed or postpone the maintenance (discretionary).
Office Supplies: A mix of variable and discretionary expenses.
Postage: Fixed expense, but can be variable when dependent upon the amount of your business activity.
Rent: Fixed expense.
Repairs and Maintenance: Fixed, variable, and discretionary; see Maintenance Supplies.
Royalties: Variable expense.
Scavenger (Garbage Collection): Fixed expense.
Training: Discretionary expense.
Travel and Entertainment: Discretionary expense.
Taxes (Payroll): Variable to your payroll expense.
Taxes (State): Variable expense.
Taxes (Federal): Variable expense.
Telephone: Fixed expense.
Water:Fixed expense.
