Adam Lean — June 30, 2018 If you are like most small business owners, you got into business because you liked the product or service that your business provides.
A cook buys a restaurant because of their passion for food.
A dentist starts a dental practice because of their expertise in dentistry.
A fitness expert buys a gym because of their love of fitness.
These are all great reasons to start a business, however, to stay in business the owner must also possess, or hire someone who possesses, financial management skills.
You see, businesses fail every day – and it’s not for a lack of passion, or knowledge, or expertise – it’s for a lack of financial management.
Business owners must continuously take certain steps to have a financially healthier business. Not just so that they will survive – but so that they will also thrive.
Here are seven steps for you to take to have a financially healthier business.
Step 1: Have clear, accurate, and timely financial reports
It would be incredibly difficult for a sports team to play their game if they didn’t know the score in real time. How would they strategize? How would they know which players to put out on the field? How would they know when they should pull together and overcome a difficult situation? How would they know when, and if, they can celebrate?
The same idea is true in business – you must know the “score” at all times. You know the score by understanding certain reports – commonly called your “financials”. These are the reports that give you the score – they tell you if you are winning or losing.
There are three common “financial” reports that every business owner should become familiar with – the Income Statement, the Balance Sheet, and the Cash Flow Statement.
- The Income Statement tells you how much profit your business has produced over a certain time – typically a month or a year.
- The Balance Sheet tells you how much your business owns, owes, and is worth at a certain point in time – typically at the end of each month or year.
- The Cash Flow Statement tells you where cash came in from (inflow) and where it went out to (outflow) over a certain time frame.
As a small business owner, it’s not only vital that you have a basic understanding of these reports, but that these reports are also accurate and made available to you in a timely manner.
Step 2: Forecast cash to anticipate a cash shortage
How do you know if you should pack an umbrella before you go out for the day? You check the weather forecast. Weather Forecasting is simply someone predicting, using their knowledge and the tools at their disposal, what the weather will be for the day.
The same concept of predicting must happen in your business, too: someone needs to predict how much cash the business will have in the near future – ideally for the next 3 months.
As you are aware, a business must have cash in order to stay in business. Because you need cash to stay in business, you must always be forecasting how much cash you’ll have on hand over the next few days, weeks, and months.
When you forecast your cash flow you will be able to anticipate when you might have a cash shortage and be able to take steps now to prepare.
Step 3: Have specific financial goals
It probably makes sense that you need to set goals, however, it’s equally important to set specific goals so that you know when the goal has been accomplished. “I want to lose weight” is not as specific as “I want to lose 20 lbs. by October 31st.”
The same is true in business – you must set specific goals. Financial goals, especially, must be specific and they must be given specific due dates. This is also known as a budget. You must “budget” financial goals that you want to have accomplished at the end of a certain time period (e.g. December 31st).
There are four main areas that you need to create goals (budgets) around:
- Sales
- Gross Profit
- Net Profit
- Cash
By creating goals (budgets) for each of these four areas, you are making a plan to meet, or exceed, your goals in each of these areas. This gives you and your team a clear idea of what you’re aiming for.
You can also subdivide the main goals within every department or product/service line of your business. For example, if you have multiple sales territories you could assign specific Sales and Gross Profit goals for each territory. Keep in mind that the sum of your subdivided goals should always add up to your main goal.
Once you set the main and subdivided goals for your business, you can then determine your “financial goal” for every month, week, and day. By doing so, you will always know what you should be aiming for in order to meet your overall financial goals.
Step 4: Assign responsibility and track each goal
It’s been my experience that for a goal to be accomplished it must be assigned to one specific person and the goal must be tracked.
The reason why each goal needs to be assigned to one specific person is that if the same goal is assigned to multiple people, I’ve found that no one person will assume the responsibility. Therefore, it’s a good idea to “subdivide” your goals, as I mentioned in Step 3, so that you can assign smaller goals to individual people.
The reason why you want to track each goal is so that the person responsible for the goal is held accountable. Plus, tracking goals keeps you, the business owner, in constant communication with your employees. Both you and your employee will know the status of the goal and can address issues that will, inevitably, come up.
Step 5: Improve Gross Profit Margin
The “Gross Profit Margin” is simply the difference, or margin, between what you sell your product or service for and how much it costs you to provide that product or service to your customer.
For your company’s financial health, you must always strive to widen the “Gross Profit Margin” as much as possible. There are two ways to do this: increase your prices and/or decrease your direct costs.
An easy way to improve the margin, but hard to implement, is to increase your prices to the highest point that the market will bear.
The other way to improve the margin is to lower, as much as possible, all the direct costs that are involved in providing the product or service to the customer. This includes labor, supplies, and other such direct costs that are involved in making and delivering your product or service.
Step 6: Improve Sales
It is obviously important to improve sales, however, the reason why this step comes after “improving the Gross Profit Margin” is that you want to ensure that you are improving, particularly, the sales of the products or services that are providing you with the most Gross Profit Margin.
For example, let’s say that Product A yields $ 10 in Gross Profit and Product B yields $ 20. By focusing your efforts on selling more of Product B, you will see a greater increase in your Gross Profit Margin.
Step 7: Improve Net Profit
Through the steps above we’ve established that your sales less your direct costs give you your Gross Profit Margin. Now let’s find your Net Profit: your Gross Profit Margin less your fixed expenses (such as rent and payroll) equals your Net Profit. Your Net Profit is what provides you cash.
So, the last step to take toward having a financially healthy business is to improve your Net Profit. To do that, you must reduce, as much as possible, your Overhead Expenses.
Overhead Expenses consist of three main “buckets”: Payroll Expenses, Marketing Expenses, and General & Administrative Expenses.
The rule of thumb when spending money in any of these three buckets is to ask yourself: “Will I make a positive ROI (return on investment) if I spend this money?”. If the answer is no, then there is no point in spending the money – it might as well stay in your bank.
To recap, here are the seven steps to take to have a financially healthy business:
Step 1: Have clear, accurate, and timely financial reports
Step 2: Forecast cash to anticipate a cash shortage
Step 3: Have specific financial goals
Step 4: Assign responsibility and track each goal
Step 5: Improve Gross Profit Margin
Step 6: Improve Sales
Step 7: Improve Net Profit
Your employees, your customers, and your family are counting on you to have a financially healthy business – a business that will not only survive – but thrive. To do that, you must take the seven steps seriously.
Get my easy-to-use Cash Flow Template that can help you forecast cash over the next three months – Click here to download.
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