CHAPTER 1 Your Financial Dashboard The Net Income Statement, Cash Flow Statement, and Balance Sheet Accounting is a really big, complicated subject. It's no surprise that many small business managers want to hand anything to do with numbers off to the "number people"--CPAs, bookkeepers, bankers, and tax lawyers. Perhaps you can relate. If terms like GAAP accounting principles, tax legislation, debits and credits, and tax forms stress you out, don't worry. First, you're not alone. Second, this book is not going to cover these topics. It is, however, going to confront you with a truth you cannot afford to deny: If you want to be successful at managing a business, you need to become proficient at handling certain numbers. Put simply, you need to be able to read and understand your financial dashboard. Think about the dashboard in your car. You have a speedometer, a gas gauge, and an oil pressure gauge. These instruments measure the vital signs of your car's operation. They give you critical information about how fast you're moving, how much fuel you have in your tank, and the state of your engine. If any one of these instruments isn't functioning or you don't know how to read it, then pretty soon you're going to be getting a ticket, stalling out, or blowing a gasket. Similarly, your financial dashboard has three gauges you need to be able to read to manage a business--your Net Income Statement, your Cash Flow Statement, and your Balance Sheet. These statements measure the vital signs of your business operations. They provide you with critical information about how much profit the business is generating, how much cash you have in the bank to run the business, and the overall health of the business at a point in time--information that allows you to make wise and timely decisions that will keep the business humming like a tuned-up car. And guess what? Your bookkeeper isn't going to make those decisions for you. He's there to make sure you have accurate and timely records of business transactions to send to your CPA. Your CPA is not going to make those decisions either. She is there to prepare your taxes and make sure you don't get audited. It's entirely possible for your "number people" to be doing their jobs superbly while you are steering your business into a financial danger zone. You could be spending money on the wrong things. As a business manager, you might be taking out crazy amounts of debt without understanding how fast that can sink the business. You are the one in the driver's seat. And if you can't read your financial dashboard, you're driving with your eyes blindfolded. Unfortunately, this is exactly what over 85 percent of small business managers are doing, according to the U.S. Small Business Administration. It's no wonder that 40 percent of these businesses fail to survive even four years. If you've heard this statistic, you've probably also heard the reasoning that it must be due to lack of start-up cash or unviable products and services. It's not. There is plenty of cash available and broad enough markets for the business you manage to find new and loyal customers. Small businesses largely fail due to mismanagement. If you want to keep the business out of bankruptcy and reach the most important destination-- sustainable profits and free cash flow--then you need to take the basic driving lessons necessary to maneuver a profit-making vehicle for the products or services you manage. You need to become fluent in reading what the financial dashboard reveals about your business. The great news is that you're entirely capable of becoming an expert at this. How do I know? Because I've taught hundreds of small business managers--including the most extreme of number phobics--what I'm about to teach you. I've seen them grasp the concepts easily and, with many wonderful "aha!" moments, immediately begin to see exactly where the risks and opportunities are because they can finally understand how to respond to the numbers on their Net Income Statement, Cash Flow Statement, and Balance Sheet. My objective in this chapter is to expand your financial vocabulary beyond "bankruptcy" and "billionaire." If you are like most small business managers, you may be familiar with some, if not most, of the financial terms in this book, but be at a total loss when it comes to grasping their meaning and real-world implications. This is like driving down the highway without being able to read the road signs. When you see a sign with the number "65" on it, there are several levels of knowledge you must have in order to read it. You need to know that it's a speed limit, and that you're expected to make sure the needle on your speedometer stays on or under a corresponding "65" mark. You also need to know what this sign implies: If you exceed this speed limit, you risk getting a speeding ticket. You may even lose your license if you test the limits too frequently. The numbers on your financial documents are like that speed limit sign. The sign doesn't need to communicate everything-- you've been taught what it means, and if you've been driving for a while, and especially if you've ever gotten a speeding ticket, then you know its implications. The sign is small, but the meaning is significant. The same is true of those little numbers on your financial dashboard. There are some nuances and calibrations to learn that are essential to you as you make day-to-day business decisions. So let's start learning the lingo. I'm going to start by giving you a basic overview of these three financial documents and what they measure, along with a brief introduction to some of the implications these measurements have for managing your business. Let's start with your speedometer--the Net Income Statement. THE NET INCOME STATEMENT The Net Income Statement, also known as the "Income Statement," "Profit and Loss Statement," and "P&L," reveals whether a business is generating a profit, breaking even, or showing a loss. If you didn't know that, don't worry. Many small business managers don't know it either. One small business manager who ran a series of salons for children attended one of my seminars. When I told her that all these terms mean exactly the same thing, she jumped up and said, "Are you kidding me? Is that what my accountant's been talking about all these years?" Accountants might refer to the Net Income Statement as the "Income Statement," typically dropping the qualifier "Net" because it's implied and they assume you know that. And now you actually do. Similarly, the terms "net revenue" and "revenue" are used interchangeably. And sometimes you may see either "revenue" or "revenues" used as the plural form to describe the total amount of net sales. None of these terms should leave you in the cold. By the way, whenever you see the qualifier "gross"--such as gross profits, gross receipts, or gross revenue--it means you're looking at those numbers before expenses or discounts are deducted. Anytime you see the qualifier "net"--as in net revenue, net expenses, or net income--it means you're looking at the numbers after certain expenses have been accounted for. Armed with this simple knowledge, you're already way ahead of the pack. Here are the key questions the Net Income Statement answers for you as a small business manager: • Is our business making any money? • Are our products and services the right ones? • Are we pricing our products and services so that we're not cheating ourselves out of a reasonable return while still remaining an attractive alternative to the competition? • Is our gross margin robust enough to run the business? • Do we know what our true direct costs are? • How do we know our marketing efforts are paying off? • Do we have the right mix of clients? • How can we work half as hard and make twice the money? The Net Income Statement will reveal whether your business is generating a profit, breaking even, or losing money. If the number on the bottom line is positive, you're making money. If it's zero, you're breaking even. If it's negative, you're losing money. The bottom line is what's left after every direct and indirect expense is paid from net revenue. That number is why you're in business. It's net profit. Excerpted from Accounting for the Number-Phobic: A Small Business Survival Guide by Dawn Fotopulos All rights reserved by the original copyright owners. Excerpts are provided for display purposes only and may not be reproduced, reprinted or distributed without the written permission of the publisher.
