Article Summary: Most small business owners, including myself when I started and operated a business, don’t jump into their entrepreneurial dream because they are particularly excited about the list of accounting chores that require daily attention. If you are excited about that, you have a leg up on the rest of us. Although I don’t believe every small business owner needs to be an accountant, among other things, small business financial health starts with having a handle on a few key metrics.
5 Metrics Every Small Business Owner Needs to Understand
Understanding these five metrics will help you know how your business is financially healthy. If there are any of these that you aren’t sure of, take some time with your accountant or other trusted financial advisor and he or she will be able to explain what you might not be familiar with.
- Income: Income is at the top of my list because it’s probably the most important. A small business without income just won’t last long. As a business owner, I was paying attention to my daily income as well as monitoring and tracking it weekly, monthly, quarterly, and annually. It’s human nature to impact the things you pay the most attention to, business income should be on the top of that list.
- Expenses: Are you on top of how much it costs to do business every month? In addition to the cost of goods sold, you can’t ignore the overhead costs associated with doing business. These include things like your lease, utilities payments, paper goods, and even things like paper towels in the bathroom. Next to income, you really need to have control of your business expenses.
- Cash Flow: The balance in your business banking account at the end of the month may not be the best measure of your cash flow. The metric I like to use is to divide your income by your liabilities and you will get a ratio that reflects your cash flow. A ratio of 2:1 or twice the assets to liabilities is ideal (granted, this can be a tall order for many small businesses), but if the ratio falls below 1:1, it’s a warning sign that you don’t have enough cash flow to support your business operations.
- Accounts Payable: Staying on top of your Accounts Payable Aging is important for a number of reasons (including how it impacts your business credit profile), but it can also be an opportunity to reap additional profits by taking advantage of the quick payment terms many suppliers offer their customers who pay their invoices quickly. For example, many suppliers offer discounts if you pay your invoice in 10 days as opposed to 30 days.
- Accounts Receivable: If you offer your customers payment terms, it’s really important to stay on top of how long they take to pay an invoice. If you offer 30-day terms to your customers, every day a customer takes over 30 days to make payment has the potential to negatively impact cash flow. For example, my profit margin was such that once an invoice hit 45 days it started to impact my profit on that invoice. After 65 days, any profit was lost and it started to cost me to do business with that customer. What’s more, the difficulty of collecting one of those invoices started to get exponentially more challenging every day it took beyond 70 days.
The most successful small business owners I’ve ever met had a really good understanding of these metrics and used them to measure the financial health of their business and build a successful enterprise.
Download "Is Your Business Financially Healthy?" for more tips on evaluating financial health
Make Your Accountant a Consultant
It’s a temptation for many small business owners to be very transactional with their accountant. In other words, the only time they meet with them is when they have taxes to pay or quarterly filings to make. That being said, I’m a big fan of leveraging their perspective and insight into the business with a more consultative relationship.
Your accountant looks at your business from a slightly different perspective than you do, so leveraging that point of view to improve the overall health of your business and increase the profit potential of your business is a good approach. I’d suggest establishing a cadence for regularly meeting with your accountant to talk about what he or she sees within your financial reports and if there are any extra profits you can either save or improve by tweaking the way you do business.
The cadence will be up to you, but a semi-annual meeting might be just as effective as a quarterly meeting depending upon your particular business. I suggest you don’t try to do it at the same time your accountant is pulling your taxes together, but set aside some time dedicated to taking a deep dive into your financial data. Don’t be surprised if he or she points out a couple of things that are obvious to him or her, but something you had not considered before. That difference in perspective is the reason you want to do this.
Your accountant will likely appreciate the opportunity to take your relationship to the next level to help you build a successful business, but you should be prepared to pay for the advice. I don’t think it will take too many visits before you start to see some value from the regular conversation with your accountant.
Every Business Needs a Profit Expert
A successful business is all about creating profits and every business needs a profit expert. Most of the time, that expert becomes the business owner, but it doesn’t necessarily have to be. In addition to marketing (or promoting your business), production (or the ins and outs of running your business), the accounting process is a critical part of every business and where the profit expert lives.
As I mentioned earlier, I don’t think every small business owner needs to be an accountant, but all the successful business owners I ever speak to have a real understanding of what the financial data in their reports are telling them and use that information to make informed business decisions. Many of them, whether they have a regular meeting cadence with their accountant or not, are in sync with their accounting process and are using that information to look for opportunities to save money or increase profit potential.
I’m convinced the single biggest mistake I made as a small business owner was that I didn’t appreciate the value of the information available to me within my financial reports. I viewed my bookkeeping duties as a chore rather than an opportunity to find profits and would put my daily bookkeeping chores off until the end of the day (which sometimes meant indefinitely) instead of looking at them as an opportunity to discover additional profits. As a result, there were many things I had to learn the hard way.
Were I to do it again, I would do those things at the very beginning of the day when my mind was fresh and I could better make decisions about how to use that information within my business.
Automate Bookkeeping and Accounting
I worked for many years with a business owner who liked the manual process of doing the books with a set of traditional ledgers. As a result, he had a great understanding of the financial health of his business and actually looked forward to the time he spent in the books. This worked well for him until his accountant retired and his new accountant wanted him to use a software program. Fortunately, making the change was fairly easy for him because he understood what was going on within his business and the accounting process.
There are several small business software programs that make accounting and bookkeeping much easier for business owners; and also enable your accountant to access your financial data remotely—making it easier for them (and you) when it’s time to file quarterly tax reports, pay your payroll taxes, and file your year end tax statements. I recommend you speak to your accountant to find out the program they recommend so you know it will successfully integrate with the system they use.
Is Your Small Business in Good Financial Health?
Although it’s not really rocket science, it does require effort and discipline as a business owner to track small business financial health. It may require you to learn and master a few additional skills, but these suggestions are a good way to start and will help you have a better understanding of what your business is doing.
Download our full e-book “Is Your Business Financially Healthy?” for more information.