A simple Google search will lead you to hundreds of different software and online options to help you run the financial side of your business. Some are probably good and others not. All of them can suffer from the same malady: GIGO (garbage in, garbage out). No matter how well the software or service works, if you don’t understand your numbers before you put them in, they will not help you to understand them any better when they spit the numbers back out!
Now, I am not anti-software, far from it. However, I have seen on any number of occasion’s small businesses that have invested financial in software only to be more confused and farther from the truth about what their numbers mean after using financial software than before. The reason was pretty simple: the business owner did not understand the numbers in their business to begin with. Reformulating them only makes it harder.
So, what I am recommending to every business owner is to build a set of financial numbers from scratch, at least at first, so that you understand very well what they are. If you are not a financial person, get some help, but make sure that the person who helps you can explain things to you properly so that you understand how your numbers work. Use a paper and pencil or a simple spreadsheet; remember that when you build your numbers up from the bottom, you will gain an intimate understanding to how they work.
Here are three questions to guide you.
Where do your revenues come from? My colleague Len Bland (www.conceptequity.com) often says to entrepreneurs looking for investors not to cite a general market percentage as the basis of potential income, but show proof that you can build your numbers from real sales. I agree with Len; whether you are selling a product or a service, how much will you sell?
It helps if you base your projections on some real research. See my Blog posting: “It Doesn’t Have to Take Big Bucks to do Research”. But most importantly, do the numbers add up in a way that makes sense? The key here is that if you have gone through this exercise, even with outside help; you will have an intrinsic sense of how your revenue works.
What are your expenses? Which expenses are based on what you sell and which aren’t? Some of your expenses will depend on what you sell (raw materials to make products or consulting hours) and others won’t (rent, utilities, administration). Separate out these two categories of expenses into different worksheets. The exercise will make you think through two important concepts: how does your production effect costs, and what does your overhead really cost? To help with this exercise, see my recent Blog, “Don’t Bump the Overhead“.
What is the timing of your income and expenses? Think about when you will need to spend money, and when will money come in. It’s great to have a profit at the bottom of a P&L, but if you are buying from vendors at Net 60 and selling at Net 90, you will have a crunch at some point. The most important document you can create yourself is a cash flow worksheet that shows the timing of expenses, the timing of income and the gap between them.
The worksheet can be as simple as 12 columns; one for each month. Three or four rows in the column can income that is due in the month, but also indicate how long ago the sale occurred (net, 30, 60, 90, 90+). Other rows can indicate expenses, both those that repeat on a regular basis (utilities, rent, administrative salaries) and those that occur based on production (supplies, raw materials, consulting hours).
Once you have gone through this exercise even once, you will have a much better understanding of the fundamentals of your numbers.