23
Profit from Your Financial Statements
Your annual business forecast and projected cash flow statement, broken down by month based upon your company's historical data, is the foundation each year for the navigational course you believe your company will take for the coming year. Your balance sheet and income statement, more commonly known as the profit and loss statement (P&L), prepared monthly and compared against the actual previous year's performance, is what keeps you on that predetermined course or shows you that a course correction is called for.
These documents should be at your fingertips at all times. If your accounting system is not capable of giving you these reports quickly, I seriously suggest you fire your accountant! With the inexpensive and user-friendly software programs such as Quicken and others that are available today, there is truly no excuse for not being on top of your financial status at all times.
You don't have to be a CPA to comprehend your “numbers” and their significance. All it really takes to understand the important numbers is common sense—comparing this time period with the same time period last year. Try to figure out why a particular profit center within your business that produces billing for its specific services (for example, tape duplication vs. equipment rental) is doing so much better/worse than you thought it would. All of the formulas and financial mumbo jumbo can be explained to you by your accountant. The importance of good financial reporting to management is that it keeps you informed of exactly what is happening when it happens and forecasts trouble, in most cases, so that you can see it coming in time to make the necessary countermoves to correct it.
The same basic approach also applies to the preparation of the business forecast for the coming year and the projected cash flow analysis. Most of the time, your business forecast will be completed by you and your management team with their personal hands-on knowledge of where the business is going and how fast it will get there. Your projections will be based on the latest actual revenue history available to you for the same time period, which is another reason to keep at least monthly detailed sources and applications of revenue (money in and money out) for each of your profit centers.
Questions such as “Will profit center X increase or decrease in sales next year (and, if so, by how much)?” are the guesstimates that you turn into projected revenue. The other angle of the exercise is projecting what the effect of more or less revenue will be on the cost of operations for that profit center. This requires the team approach because of the many factors that can affect your projections. Have you added equipment or personnel or additional square footage to a particular profit center, which will affect total revenue? Are your marketing efforts working to let your potential customers know more about a particular service you are offering? If you are phasing out a particular service because of technological or market changes (such as high-speed cassette duplication), how are you going to replace that revenue and utilize that floor space and personnel?
Once these decisions are made, many times by estimating how much a particular profit center will increase/decrease by a percentage of last year's business during the same time period, you can turn your business forecast over to your accountant/bookkeeper to prepare the projected cash flow analysis. This important document tells you, on the basis of your projected revenue, expenses, and accounts receivable collection, just how much cash you will have at the beginning and end of each month. Once you know this information, which is presented in monthly columns showing a beginning and ending cash balance, you will quickly see the holes in your financial planning that need to be filled. This will include items such as cash shortages, delay or advance of planned expenditures based on cash receipts, additional hiring/layoff of personnel, and so on.
Next comes your company balance sheet, which is historically formatted to show the financial condition of your business as a “snapshot” at a given moment in time. This overall financial status report is usually created at the end of your 12-month fiscal year for income tax purposes. Often, it is also prepared after 6 months of your fiscal year to update your lender and your partners. Simply stated, it is: assets minus liabilities equals the net worth (equity) of your business. If you have or desire a substantial credit line, or want to lease expensive equipment, your lender will require a current balance sheet, most likely on a monthly basis, and may require your business to maintain certain acceptable ratios such as: current assets vs. current liabilities (the “current ratio”), cash plus accounts receivable vs. current liabilities (the “quick ratio”), an acceptable debt to asset ratio, and an average collection period for your accounts receivable. These acceptable ratios differ by type of lender, but are a quick and efficient way for you or a potential lender to analyze your business.
If you or your accountant is able to provide a professional business financial analysis, you will know in advance what your chances are of getting the credit line or lease approval that you seek. This can be accomplished simply by asking your potential lender their requirements based upon the financial formulas mentioned above and any others they may utilize, such as requiring a certain number of your annual income tax statements. This is a big planning advantage. In addition, this approach saves the potential lender important financial analysis time and shows them that your business is being run in a sophisticated financial manner. Once you understand what the lender/leasing company demands in financial performance from you in order to grant your loan/financing request, you can work toward that goal. As a result, you gain a reputation for rarely, if ever, having a loan request denied. It will also clearly show you what you really can and cannot afford for your business.
The most important financial indicator that you have available for tracking the day-to-day financial flow of your business is your profit and loss statement (P&L). Just as you should annually review the necessity for all of your studio business forms, you should annually review with your tax accountant the method and form of clearly reporting your income and expenses historically, for the present year, and for your projections in the future. Unlike your balance sheet, which is fairly rigid in form, you can structure your P&L almost any way you wish within the required format (sources of income minus current expenses = profit or loss).
What simple set of categories will best show you where the problems and the profits are? How can this format of your P&L best help you with projecting your budgets and monitoring your expenses on at least a monthly basis? This P&L will be the first “green light” or “red light” to show that you are delivering a better or worse than historical average performance for your business. This allows you to make the course corrections necessary to optimize your profitability.
Many times, it is wise to have separate P&L statements for each profit center within your business, which are then combined to make your overall company P&L. You can then isolate and determine how various services provided by your company are performing, one vs. the other, and calculate which areas of your business are the most profitable. You can then focus your efforts to maximize revenue and increase profitability, with adjustments being made as required.
These reports are then furnished to department and division managers (or just to yourself), who can then account for any abnormal deviations from normal expense or income performance for various areas of the business. The result will most often be more profit, which should lead to your ability to grant regular raises for the winners. You will develop a much healthier business, which should grow and prosper further. It's called success.
(See Appendix II for actual profit & loss statements, balance sheets, and explanations.)