Using Financial Statements to Gain a Competitive Advantage

Initially, you’ll need the confidence, intelligence and ambition to implement and execute your business plan, but beyond that, there’s one essential ingredient that separates the few from the many. The problem is, this one critical ingredient often gets the least attention. So what is this all-important ingredient?

The Numbers Never Lie

Business owners are, by nature, focused and driven. They’re focused on building the next product and closing the next sale, just as they should be. Yet, when asked what last month’s revenues were, or what accounts receivable are today, they may only have a foggy notion at best, even though the financials are the tools that help manage successful business ventures over the long haul.

Consider this example of a tradie’s emerging company with sales growing at 10 to 15 percent every month.

The company is profitable, but never seems to have enough cash. Often times, the business will attempt to fix this, incorrectly addressing the problem, or ignore it, not being able to recognise the importance of the situation. Either way, the business ultimately fails because it’s strangled for cash.

But the informed business owner, the one that not only listens to what the warning signs tell him, but also knows the proper numerical cure, can keenly address the issue by slowing sales and instead focusing on his lagging accounts receivable process. This allows the business to pay suppliers and vendors promptly in order to get working capital back to appropriate levels. Suddenly, cash flow increases, and the sales process can ramp up once more.

Of course, this is just a singular example; there are several numbers that a business owner needs to know at all times. Here is a list of the most important:

1. Working capital

Working capital is the capital you have available to work with today. This is determined by subtracting current liabilities from current assets. A rule of thumb says you should have $1.50 to $2 of current assets for every $1 of current liabilities.

2. Revenue

Know your sales on a monthly, quarterly and year-to-date basis. Compare these to your plan to see if you are behind or ahead.

3. Gross profit

Gross profit can be calculated by subtracting direct product cost from revenue. In most cases, there should be 50 percent or more of your sales volume left after you subtract your direct costs (cost of goods sold).

4. Profit margin

Subtract the total of your general and administrative expenses from your gross profit, then divide that number by your sales. This number will tell you how profitable the business is. If the number is negative, you are losing money.

Make sure the number is as good as or better than others in your industry. If the typical profit margin in your industry is 12 percent and yours is 5 percent, then you are not managing your business as well as your competitors. Find out what you need to do to improve that margin.

5. General and administrative expenses

There are typically three biggies over which the business owner has a great deal of control. Know these numbers, and be prepared to adjust them to the current business environment.

They include:

6. Salaries and Wages

This is often one of the largest expenses for any business. When business slows, you need to be positioned to reduce wages and salaries quickly and decisively. This isn’t always fun, but it’s a decision that a smart, numbers obsessed business owner must make.

7. Marketing expenses

The largest marketing expense is often advertising. You should be able to turn sales up or down by adjusting your advertising expenditures. If there does not appear to be a correlation between advertising and sales, then there may be something wrong with your advertising strategy. The important point is that if you do not compare your advertising expenses and sales, how will you know the effectiveness of your marketing?

8. Research and development (R&D)

R&D effectiveness is not as easy to quantify as advertising. However, the savvy manager should set a budget based on anticipated costs necessary to achieve a certain goal. Be certain to periodically measure your progress by comparing the amount spent with the proximity to the goal.

Like salaries and marketing, this is a variable number that must be monitored and adjusted quickly to meet current needs.

These eight numbers are not the only numbers a business owner should know, but this is certainly a good start. Commit to knowing these numbers at all times, creating procedures as necessary in order to measure those that are unknown and/or not tracked.

Business Owners who know their numbers have a tremendous advantage over those who do not. The financials tell a story – and understanding the story behind your numbers can be one of the most important ingredients for long-term success.

SP Solutions can advise you on how to grow your business into a multi-million dollar consume that’s far less reliant on you. Call (03) 9355 0500 or send us a message by clicking here.