Saturday, July 18, 2009

Understanding your financial statements...

Cash on cash return, return on investment, cash flow statements, cash accounting, accrual accounting, on and on and on...where does it end? Many business owners tell me they manage their business by knowing how much is in the banking account. They ask so I really need to be concerned about how to read a income statement, worse yet a cash flow statement?

The short answer is no, many people have run very successful businesses for a long time without having the true ability to read a financial statement. The better question is can I better manage my business if I understood some simple concepts of how to read financial statements and do some simple analysis. Well, the long answer to that is, yes!

Many business owners will tell you that while they may have the ability to run their businesses they are weary of their inability to fully understand what their accountants are telling them. Can you really manage the unknown? Take for instance the plumber who didn't know where the water needed to come from or where it needed to go. He wouldn't be able to perform at his best without that knowledge. Or the electrician who knew that they needed to have a dedicated circuit for an outlet 50 feet from the electrical panel but didn't know exactly what needed to be plugged in there and they place a 120 volt 30 amp circuit when a 240 volt 15 amp circuit was needed. In both cases they can "do something" and probably have to make adjustments along the way and maybe get the job done after a few mistakes. It is the same in running a business, having the right information at the right time allows you to better run your business.

Building a budget in the fall for a January 1st fiscal is very similar to finding out all available information before you begin a plumbing or electrical job. In both cases with contracting work and building the budget you may run into unforeseen issues, but at least you have some guidance before you begin.

Understanding your financial statements so that you can make great decisions is not a must, but it is something that you should strive for. The ability to review data and understand what is going on within your business will help you sleep better at night and it will allow you to make better decisions. But remember looking at financial statements is like looking through your rear view mirror. You're reviewing what happened. You can certainly adjust your course based on this information, but it may take a little while to make the adjustment. Once you are better educated to read financials the next step is to develop a way to build forward looking metrics to allow for more timely adjustments to your course, a business dash board if you will. Business dash boards will be the next blog post, so stay tuned!