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As a small business owner, what issues are you faced with in understanding financial performance?
Almost every small business today has an accounting system (of some kind) in place. Do most small business owners understand what their financial performance trends are and where they are headed over the next 12 months or are there other basic issues in understanding financial performance?
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3 Answers
Short answer, No.
The financial side of the businesses, with or without accounting software, is the most mystical portion to most small business owners. Remember, most small business owners got into business because they enjoying making something or providing some service, not because they were a financial wiz.
The biggest problems an owner faces is understanding the relationship between different metrics within their particular business. While most industries have standard metrics and thresholds, like a gross margin or an inventory turnover rate, which can tell managers the long-term direction of the business, the unique situation in many small businesses make some of the standard metrics worthless and places importance on some metrics the industry typically overlooks.
A solid financial plan specific to the business will included the particular metrics important to the company. While some CPAs are capable of building such a plan, you often need an adviser in business Finance not accounting, the specialty of CPAs.
I agree with Anthony. His short answer is right on target, as his explanation in some respects to the role of the CPA in a business.
That role looks at the company on an annual basis (or quarterly) where a CFO or similar person looks in all time periods, now, short-term, mid-term and long-term.
To answer specifically the question; small business owners don't understand cash and it's cousins financing and spending. They understand selling and for the most part know when they are making a dollar on a sale and when they aren't, but that's where it ends.
Metrics, as Anthony stated need to be used to gauge the overall (and specific) performance. The key metrics I have used (in non-inventory situations) is current ratio and a/r aging (turnover).
I then know a) can I meet my short-term cash needs and b) how fast my money is coming in. Since for the most part I can control my variable payables (outflow - I can slow payments) and hopefully my spending (or not, another issue with many owners) I can manage the business finances.
The question is, can the business owner understand and apply these concepts. I have found sometimes never....
Makes for interesting times....
It is imperative that business owners and managers develop some basic financial management skills. Basic skills in financial management include critical areas such as cash management and managing profitability.
Profitability is one of the most important Performance Measurements a company can monitor. Unfortunately, many companies have a myopic view and measure only one aspect of profitability.
A company's profitability is the net result of a myriad of business decisions involving various departments. The sales department determines the selling price, the purchasing department determines the cost to produce, operations determines the labor and cost to operate the facility and management determines the overhead cost. Combined --all these people (and their decisions) affect the profitability of the company.
The two most common mistakes are:
(1) focusing primarily on the profitability of a project, product or service and ignoring the cost to operate or
(2) focusing solely on the bottom line and not understanding the effect each stage of the business cycle has on profitability.
There are a series of ebooks written specifically on this topic. They can be purchased at www.BusinessSimplyPut.com ebooks and resources.
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