A business exists for two reasons and two reasons only:
- To pay its owners a decent income.
- To increase its value so the owners can one day cash out.
And yet very few business owners spend any time managing the most important aspect of their business; the money$$$.
Most follow the ‘Once a Year Rule’ … once a year they hand over the paperwork to the accountant. She goes away and a few weeks later reappears with beautifully printed reports called The Financial Statements. They are immediately filed away.
This is not managing the money! Managing money is paying constant attention to the key financial numbers. Here are those numbers.
Cash flow ~ the flow of cash into and out of the company. The funny thing about cash flow is that cash always flows out faster than it flows in! It is easy to understand the present cash situation; look at the bank balance. The important thing, however, is to know what the cash position is going to be in the future. In that way you can prepare ahead of time for negative cash flow or take advantage of positive cash flow through the use of short term investments. Read our May 3rd Blog ‘Money In/Money Out’.
Revenue ~ this is the simple one. Everyone understands revenue right? Wrong! Is the revenue profitable? For example, are there some services you are offering that you know to be unprofitable; what percentage of the revenue is that? Do you have any clients that are unprofitable? Check out the 80/20 Rule. 80% of your revenue comes from 20% of your clients. Are they the 20% of clients you want? Dig deep. Really get to know your revenue; this is after all your best friend!
Gross Profit ~ this gives you the first indication that something might not be right with the revenue. You arrive at the Gross Profit by subtracting the Cost of Revenue (i.e. cost to create and deliver the products) from the Revenue. Every industry has its own benchmark for the gross profit. For example, most service type businesses aim for a gross profit of not less than 50% of revenue. Assuming you are pricing your delivery properly, you know if your Gross Profit is less than 50% then some of your revenue is not profitable. Act on this knowledge.
Expenses ~ this is the cost to run the business. There are two types of expenses ‘ fixed and variable. The fixed expenses are just that; fixed. For example, rent or equipment leases. Fixed expenses are difficult to reduce and so the best strategy is to avoid minimize the number of them. The variable expenses are discretionary. For example, marketing costs or team parties. Obviously some are more discretionary than others! Cutting back on marketing costs may save a few dollars but it might also slow revenue growth. The expenses must be managed closely and diligently. If expenses are too high no profit is made. If no profit is made you can’t pay yourself a decent income and the business doesn’t grow in value. Read our May 17th Blog ‘Are You Paying Yourself Enough?‘
Net Profit; this is where it all ends! This is the money left over when all expenses are deducted from revenue. The net profit can be used in a number of ways:
- Ploughed back into the business to facilitate further growth activities
- Provide the owners with dividends and/or bonuses
- Invested in other ventures that help build the value of the business
- Invested in stocks or bonds to grow the absolute value of the business
- Or a combination of these
Net Profit must be managed regularly. Don’t wait until the end of the financial year to find out the net profit. It must be measured and managed all through the year so the resulting net profit is adequate for the long term growth plans of the business while minimizing the contribution to the Government of Canada.
Focus on the reality that your business must pay you a decent income and it must increase in value so that one day you can sell it. Otherwise you are simply creating a job not building a business.
Manage the numbers by planning revenue and expense targets and by consistently measuring the progress. Know your numbers; the numbers don’t lie.
