Tag Archives: balance sheet

Administrative , , Leave a comment

Staying Alive: KPIs Make the Difference

by

You’ll recall the overview of the 5 stages of growth that businesses of every type or size experience, if they survive, as discussed in the April 11 post. Today we’ll explore how three standard financial statements can help business owners maintain the health of their venture and position it to survive long enough to pass through the growth stages and grow as intended. Actionable data—Key Performance Indicators— are waiting for you in those financial statements and the numbers will show you how to best manage your entity.

Math might not be your strength but little by little, you can learn to recognize and interpret the numbers and allow your KPIs to do their job and function as guard rails that will make you an astute decision-maker. Running a business is all about making informed decisions that help your business operate efficiently and grow successfully. Just as your primary care physician monitors numeric values associated with certain of your bodily functions—-vital signs, your personal KPIs—-you do the same for your business.

Because 70% of businesses will fail after 10 years and you don’t want it to happen to you, let that scary thought motivate you to keep both hands on the wheel and manage your business wisely. There are many factors to evaluate, including your client list and the sales of your products and/ or services, but today’s focus is the financial management that your monthly or quarterly bookkeeping statements allow you to do. BTW, those statements also make preparing your quarterly and annual tax forms are more efficient and less stressful process.

Basic 3 financial statements

  • Income (P & L) statement. The income statement, also known as the profit & loss statement, is also known as the profit-and-loss statement. It sums up the money you collected from operations plus any other gains, as well as the money spent over a specific period of time. The basic formula is: Net Income = (Total Revenue + Gains) – (Total Expenses + Losses). You want your net income to be positive.
  • Cash-flow statement. The cash flow statement shows whether your business can pay its bills. This will give you a sense of where your business’ cash will come from and where it will be spent. Here you can also see customers that may “slow pay” to decide if they are putting your cash position in jeopardy.
  • Balance sheet. Your balance sheet summarizes your company’s assets, liabilities, and owner’s equity (or investment in the business), providing a snapshot of the financial health of the business at a point in time.

Trend analysis

Looking for trends can help you determine which products or services to promote, keep in stock, or stop selling altogether. Certain of your products or services may sell more frequently during some seasons and less frequently during other times of the year. Special promotions, perhaps advertised by way of email marketing and social media, is just one smart decision that examining sales trends can lead you to make. Another smart decision you might make is to initiate a demand pricing strategy and increase the prices of popular products or services during the time of year that they sell the most.

Get an unfiltered look at what clients prefer to buy on the top line of your P&L, Gross Sales Revenue. While many obsess over the bottom line, because it shows the total revenue earned (or lost) for the month, quarter, or year, the top line should not be ignored. When the top line shows healthy sales, it’s obvious that you’re doing something right. After that, it’s a matter of controlling expenses. Keep an eye on the trends in top line sales data, it is instructive.

Analyze and interpret

Also monitor your expenses, fixed and variable. Fixed (operating) expenses include office rent, W2 payroll wages and utilities. Variable expenses are often sales related, such as marketing and professional development. Increasing expenses may mean that you’ll have to alter some other part of your business (for instance, increasing prices when expenses grow). If certain clients are making late payments , potentially causing you to make late payments to your creditors, consider requiring late or slow payers to make a deposit of at 25% or so on the project you’ll do and/ or increase your project fee for late paying clients.

As you become more proficient in your understanding of financial data and interpretation, you can also calculate and follow certain financial ratios that can provide guidance. On your Balance Sheet you can calculate Net Working Capital, which is your current assets less your current liabilities. This is the amount of money you can use to operate the business day-to-day and invest in growth.

The Current Ratio equals current assets divided by current liabilities. In general, a ratio of one (1) or less indicates that there is not enough available capital to pay your expenses, which is a real problem. If your Debt-to-Equity Ratio (total liabilities divided by total assets) is greater than one (1), it is understood that the business is carrying too much debt—literally at a dollar to dollar ratio. Credit card debt and perhaps also other borrowing as a means to grow your business or pay expenses is bound to cause lending institutions to see your company as a credit risk. Direct your resources to paying down debt.

Bookkeeping software

If you have few transactions in a typical month, you may prefer to record client financial activity in Excel and send invoices in PDF format. If you have several client bills/ month you may prefer to install bookkeeping software. Freelancers and small business owners tend to work with small business specific, cloud, industry specific, or open source software.

Bookkeeping/ accounting software usually fulfills several functions in addition to generating the basic financial statements on a monthly or quarterly basis. You’ll also receive a collection of services that may also include invoicing, inventory management, payroll, financial reports and customer relations management features such as tracking client interactions, sales history and maintaining contact info. To compare features and monthly costs of several software services, click https://www.business.org/finance/accounting/best-bookkeeping-software/

Thanks for reading,

Kim

Image: This photo is from an album Elstner Hilton compiled in Japan between 1914 and 1918.

Business Plan , , , , Leave a comment

Getting Started With Financial Projections

by

Whether you are starting a new business, expanding or scaling an existing venture, or searching for investors, creating realistic financial projections is a vital component of the process. You’ll rely on those projections to make informed decisions as you execute the plans for your business. It’s imperative that you have a very good idea of the amount of money you’ll need to move forward with your intentions and how much money you can expect to earn as a result—-and also about when the expected revenues will arrive.

So, what is involved and where can you begin when your goal is to create financial projections for your business? The answer is—- surprise!—-do some homework first. Below are factors to research and help yourself create financial projections that help define the path to success that will work for your organization.

Your financial projections will be detailed in the basic financial documents—the Profit & Loss (Income) Statement, the Balance Sheet and the Cash-flow Statement. The Break-Even Statement will help you predict how much revenue the venture must generate to break even in terms of revenues versus expenses and when that’s likely to occur.

Something to keep in mind when you contemplate the need for financial projections is the distinction between projecting versus budgeting. Think of financial projections as a prediction, and budgeting as your plan. When you do a financial projection, you see what direction your business is headed in, based on past performance and other factors and use that to anticipate the future.

When you create a budget, you plan how you’re going to spend money based on what you expect your finances to look like in the future (your projections).

How big is your target market?

Start-up costs

This is the beginning in terms of your research and big question to answer. Understanding how to build a profitable business starts with determining the size and revenue (sales) potential of your market; if there aren’t enough buyers available, you’ll be unable to succeed. Most industry associations publish research regarding the size of their industry. Identifying three or four close competitors is also useful. Competition is a good sign, confirming that there is money to be made. You need to understand the annual sales volume expectations of your venture.

Expenses are much easier to predict than revenues. Start building your forecast model by outlining your fixed expenses, meaning rent, utilities and insurance. Next, consider the variable expenses, such as salaries, cost of goods sold (or the estimated value of the time it takes you to produce the service you offer). Business permits, required certifications and a marketing budget, for example, are other variable expenses to account for.

Also factor into your start-up costs your best estimate of site buildout and/or necessary equipment—coffee making machines, cash registers, computers, printers, online booking software, online payment or mobile payment plan, desks and chairs—in your financial projections.

Revenue projection

Thinking about how much revenue the venture will be able to generate, i.e., creating a sales forecast, attempts to predict what your monthly sales will be for up to 18 months after launching your business. Start-ups can make their predictions using industry trends, market analysis demonstrating the population of potential customers and consumer trends.

A pricing strategy is an integral component of a revenue projection. Research average industry pricing to ensure your prices are reasonable. Start by identifying the top players in your market. Then visit their locations or websites to determine how they price their products and services.

Cash-flow

A cash flow statement (or projection, for a new business) shows the flow of dollars moving in and out of the business. This is based on the sales forecast, your balance sheet and other assumptions you’ve used to create your expenses projection. If you are starting a new business and do not have these historical financial statements, you start by projecting a cash-flow statement broken down into 12 months.

Identify your assumptions

Any forecast requires you to make assumptions about possibilities that are outside of your control. The best way to manage these assumptions and avoid subconscious bias is by explicitly identifying and documenting them in writing.

The assumptions you should list include how much the market will grow or shrink, based on your research about the industry and local or national economy, changes in the number or activity of your principle competitors and/or technological advancements that will impact your business.

Break-even point

Together, your expenses budget and sales forecast paints a picture of your profitability. Your break-even projection is the date at which you believe your business will become profitable — when more money is earned than spent. Very few businesses are profitable in their first year. Most businesses take two to three years to become profitable. The Break-Even Statement will help you consider and plan for how long and how much revenue the venture must generate to break even in terms of revenues versus expenses and position the business for profitability. In other words, you’ll map out the scenario of pulling the business out of the red and into the black.

Thanks for reading,

Kim

Administrative , , , , , Leave a comment

Paying You: How to Pay Yourself When You’re the Business Owner

by

Freelance consultants and business owners dedicate a considerable chunk of mental bandwidth to thinking about how to generate business, because the top line matters. We think a lot about making money, but we may not devote much time to thinking through the mechanics of paying ourselves once the money arrives.

Sole Proprietors and single person LLC owners may consider the self-payment process a no-brainer—as invoices are paid, one simply deposits the money into the business bank account. But like so may actions that seem easy at first glance there is usually a right way, a smart way, to pay oneself as a self-employed person.

So—are you on your business’ payroll or do you take payments from your business in the form of owner draws? Do you and your business partners take guaranteed payments (salary)?  Are you paying yourself too much or not enough? How can you tell? Also, where in your business financials are the payments recorded?

Business type Payment Tax return Payroll Tax

Sole Proprietor Owner’s draw         1040/ Sched. C     Yes                                

Single LLC Member draw 1040/ Sched. C Yes

Multi LLC Member share 1040/ Sched. K-1 Yes

S Corporation Dividend/ wage 1040/ Sched. K-1 Yes

C Corporation Dividends 1040 dividends not on dividends

Sole Proprietor

Business owners and Freelancers who adopt this, the default business structure, pay themselves through an owner’s draw, i.e., the amount of money taken from business earnings, after expenses and taxes, by the owner for his/her personal use. The payment is called a draw because money is drawn out of the business.

Sole Proprietors usually take draws by writing a check to themselves from their business bank accounts. Smart Sole Proprietors will then deposit that check into a personal bank account and avoid co-mingling business and personal funds, a practice that inevitably leads to accounting and tax complications. The owner’s draw doesn’t affect business taxes because the net income has already been taxed. The draw is also not a business expense. From an accounting and tax perspective, the owner’s draw is income distribution. Owner draws are recorded on the Balance Sheet.

Limited Liability Company (LLC)

LLC owners, who are known as members, are not (always) considered employees of the entity and therefore they do not (always) take a salary as would an employee. LLC members, especially single member entities, usually pay themselves with a member’s draw, which is taken from the member’s capital account (business bank account). Multiple owner LLCs are considered to be partners in the business and pay themselves with a member’s share distribution, also taken from the member’s capital account. 

While members may periodically draw from their capital account, a draw is in reality an early withdrawal of anticipated year-end profits, a goal that is perhaps at top-of-mind at multi-member LLCs. Whenever a member receives a draw during the year, his/her capital account decreases, but if the business shows a profit at the end of the year, the member’s capital account will increase in accordance with the percentage of ownership. If a member owns 25 % of the LLC, then s/he can expect to receive 25 % of year-end profits. Single member LLCs own 100 % of the entity and are entitled to 100 % of the profits. Member draws are recorded on the Balance Sheet.

A working member in a multi-member LLC has the option of either receiving a guaranteed salary amount as an LLC employee, or paying oneself with a member’s share distribution, as will a single member LLC owner. Members who are strictly silent partner investors and do not work in the business are not entitled to period draws, but will receive their member’s distribution of profits in accordance with their ownership percentage at the end of the tax year. 

The member salary, known as a guaranteed payment, is not based on the percentage split agreed upon in the LLC operating agreement but based on the work the member performs in the business. Unlike member distributions, guaranteed payments are recorded on the Profit & Loss (Income) Statement and are taken from business profits.

The LLC must be diligent about filing the correct tax forms on behalf of members and maintain accurate accounting histories for everyone throughout the year, to reflect member payment choices. Members paid as LLC employees must file IRS Form W-4 to calculate the amount of payroll tax withholding taken from from each paycheck. The member is then treated as a W-2 employee of the LLC. If the member is paid as an Independent Contractor, then s/he must file IRS Form W-9 with the LLC and the LLC must file IRS Form 1099-MISC by the end of the year. All member draws or distributions are deducted from the amount of profits assigned to the capital accounts, based on ownership percentages.

Corporations

An S Corporation is in reality either an LLC or C Corporation that has elected for special tax treatment with the IRS. S Corp income, losses, deductions and credits pass through to its shareholders’ personal IRS Form 1040. Shareholders then report the business’s income and losses on form 1040 and are taxed at their individual income tax rates. C Corps are subject to double taxation—a separate corporation tax and when dividends are paid to shareholders, that amount is recorded on IRS 1040 (but there is no payroll tax).

S and C Corporation owners who work in the business pay themselves a regular “salary” and also distribution payments. S Corp owners are usually employees of the business. Owners who work as employees must be paid a “reasonable salary” before profits (dividend distributions) are paid and the salary is subject to payroll taxes. The IRS has guidelines that define a reasonable salary, based on job responsibilities. Salaries are generally taken from business profits.

Owners of C Corps can elect to pay its shareholders a cash dividend, which is a distribution of company profits. However, the C Corp board may choose to retain either the entirety or some portion of business net profits and decline to pay a dividend in a given quarter or year. If a dividend is paid, that amount is added to income reported on the shareholder’s personal IRS Form 1040. The company records dividend payments on the Balance Sheet.

S corporation owners have been known to request that their corporations pay them little or no salary, since salaries are taxed, and instead take payments as dividend distributions, which are not taxed. The IRS has stepped up enforcement on this issue and in 2000 audited thousands of S Corps whose owner the IRS concluded had received a suspiciously low salary and very generous dividend distribution, in an apparent attempt to evade payroll taxes by disguising their salary as corporate distributions.

Thanks for reading,

Kim

Photograph: Pay day on a U.S. Navy cruiser (1942)

Business Plan , , , Leave a comment

Starting A Business? Consider Your Financials Part II

by

Learning to create the financial documents for your business  is a worthwhile endeavor.  Make yourself do it! You will gain a significant understanding of your business.  You will learn the art of financial analysis.

Retaining a bookkeeper and accountant to produce the monthly statements and prepare the taxes is not enough.   In most cases, they don’t know your business well enough to make important decisions.  They can tell you when to cut expenses, but they lack the hands-on overview that effective decision making requires.

That responsibility (and privilege) is yours alone.  Little by little, even those who may be intimidated by numbers can become comfortable with the process.  Every business owner is the company CFO.

THE PROFIT & LOSS (INCOME) STATEMENT

This statement demonstrates whether or not the business is making money.  It will be useful to generate  a P & L statement every month, to chart your progress and help you pay attention to what the numbers are telling you.  It is an excellent analytical and decision making tool.

Many entries from the Cash Flow statement will also be listed in the  P & L:  sales revenue generated from each product and service;  variable selling expenses such as raw materials, labor, equipment rental and advertising;  and fixed costs such as rent, office staff salaries and utilities.  When you’re financially able to do so the owner’s draw,  i.e. what you pay yourself, will be listed here as a fixed expense.

At the top of this statement, enter gross revenues (sales). There are also lines for beginning and ending inventory and cost of goods sold.  Subtract COGS from gross revenues to reveal the gross profit.

Fixed and variable  expenses are tallied and subtracted from gross profit earnings to give you the EBIT: earnings before interest and taxes.  Loan interest payments and all taxes are then entered and subtracted also, to reveal in the bottom line of the statement the net profit or loss.

THE BALANCE SHEET

The Balance Sheet shows the financial picture of your business on a particular date.  It demonstrates what the business owns and owes on a given date, usually at the end of the fiscal (or calendar) year.

The Balance Sheet is divided into 3 categories:  Assets,  Liabilities and Net Worth (owner’s equity).  All business assets such as cash in the bank,  equipment owned,  inventory, property owned, office furniture and accounts receivable are considered assets and are entered in the plus column.

Business debts and obligations, e.g. loans and loan interest payments, accounts payable and taxes owed are entered into the minus column.  Net worth emerges when liabilities are subtracted from assets.

THE QUARTERLY BUDGET REVIEW

The Pro Forma Cash Flow statement, which provides a projection of what cash can reasonably be expected to flow into and out of your business in a given month (or quarter), should be validated by a Quarterly Budget Review.   Also called the Cash Flow Statement, this document gives the actual cash flow numbers for your business and is created after the fact.

Now you can compare your best guesses to reality.  Are you over or under budget? What has been over- or underestimated? Do you need to trim or stagger certain expenses in order to pay the bills every month? How accurate were your sales projections? Moreover, how much are you spending to make the sale?

Needless to say it will benefit you to trim expenses wherever practical and control COGS by locating the lowest cost wholesalers and raw materials sources, to free up cash so you can comfortably pay the bills each month,  pay down business debts and  perhaps  allocate money for useful promotional and advertising campaigns. You will also want to take that owner’s draw as soon as possible!

We’ll conclude the money portion next week with a look at what investors and lenders will also want to see.

Kim