How to generate a financial report that provides better financial insights
I was invited to breakfast one morning by a CEO of a food service company. She came to the table armed with an inch-thick sheath of papers, and told me the stack represented her controller’s financial statement.
“This is too much to deal with,” said the successful businesswoman. “I can’t make heads or tails of it. And you know what? I receive a financial report like this every month!”
I told her I’d take the stack back with me, and return with a financial tool presenting the data in an easier-to-absorb format. At our next meeting I handed her the month-to-month worksheet I’d designed and said, “Rather than going through a dozen of those inch-thick stacks every year, let’s take the critical top-side income statements and line them up month-by-month on this one sheet of paper.”
Before delivering it to her, I’d dropped in the April numbers to serve as a guide, with the other columns remaining blank. I told her to give that worksheet to her controller, and have him complete it month by month.
Saving Time for the CEO
I only wanted her looking at the top-side numbers, not all the other detailed figures. I just wanted her to deal with total revenues month-to-month, the gross margin month-to-month, and the total overhead month-to-month. The top-side numbers were what she needed to gain key financial insights.
The worksheet was designed to display the actual numbers reported and the numbers that had been budgeted for the month. She had 25 different operating units, all of them captured in columns on her spreadsheet. She could skim across those 25 columns and quickly see how her company was doing.
As part of this financial tool, I had also calculated a few financial ratios and percentages. She could compare one operating unit versus another, and examine the gross margin percentage. That would tell her how one operation was performing versus the next. The same thing was done with operating costs as a percentage of sales. That told her how each operating unit was managing costs, and whether each one was performing as projected.
Using this important financial tool made the CEO more productive. First, she saved time, because she no longer had to wade through inch-thick monthly reports. Second, she had crisp financial reporting that indicated specific, targeted issues to discuss with management.
Deeply appreciative, she said, “Y’know, after all these years of being in the food service business, I finally understand what my numbers are telling me.”
In my next blog, I’ll explain how this time and labor-saving financial tool can be created for your own company.
Read on to learn the common ways cash flow is mismanaged — and what CEOs can do about it.
An all-too-common source of trouble for small and mid-sized businesses is the failure to successfully manage cash flow. Cash flow is the lifeblood of a business, and if it’s not managed properly the company won’t survive for long.
What are the most common ways cash flow is mismanaged?
Cash Flow Mismanagement: Receivables
The trouble begins with failure to adequately manage receivables. When receivables get out of hand, running 60 days or more, your customers are using money that should be yours.
That cash flow failure in turn leads to trouble paying your own suppliers and vendors, who may respond by asserting that if they are not paid in a timely fashion, they are going to start shipping goods cash on delivery. The message from those suppliers essentially is, “We’re not going to be your banker.”
Cash Flow Mismanagement: Pricing Strategy
Cash flow management problems can also result from the inability to price your goods and services correctly.
In many cases, companies experiencing problems are under-pricing products and services. Even a tendency to slightly under-price can cause cash flow problems over time, as that slight differential inexorably builds up to a substantial cash flow shortfall.
Compounding the problem, this cash flow situation cannot be quickly rectified. The difference can’t be made up in one price increase, as it will likely be too much for customers to tolerate. Reviews of pricing must be tackled on an annual basis.
Cash Flow Mismanagement: Paying Attention to Margins
Companies tracking cost of goods sold, or cost of sales, must recognize those are direct costs — such as raw materials and subcontracts — related to sales. Accept a price increase from one of your vendors, and your margin has just been eroded. That can only be overcome by cutting costs elsewhere, or increasing pricing.
Whether you cut costs or increase prices will vary on a case-by-case basis, but either scenario presents obstacles. Most small businesses are hesitant to hike prices. But conversely, there are only so many ways you can cut costs.
If cash flow problems are not addressed, they will only fester and become even bigger issues. Typically, cash flow management issues result from inexperience. The business owner has no experience in analyzing cash flow problems. That‘s why it‘s important to either consult with a seasoned expert in these matters or hire an interim CFO. I’ve dealt with scores of companies with cash flow challenges, and have been able to counsel CEOs in making strategic financial decisions that have altered their companies’ fiscal trajectories.
Does your company have cash flow management issues? Let’s address those problems together, before your company’s lifeblood is drained.
In today’s financial climate, we as Americans have put aside the age-old adage of “Neither a borrower nor a lender be,” preferring instead to make the most out of our opportunities – and when there are none directly in front of us, preferring to create our own opportunities. In case you missed last week’s blog, this month’s series focuses on alternative funding options for aspiring entrepreneurs; today’s, specifically, is on the recently developed peer-to-peer lending system.
Week 2: Peer-to-Peer Lending
Peer-to-peer lending, or social lending, removes the traditional financial institution from the lending process (known as disintermediation) and directly connects people who need money with people who have money to invest. The loan works as a traditional loan, with a set interest rate and a period of repayment, so peer-to-peer lending from an investor’s standpoint is considered a for-profit activity, but with a greater amount of flexibility for both borrowers and lenders.
What differentiates peer-to-peer lending from other types (say, borrowing directly from a friend or family member) is the starring role the Internet plays – specifically, social networking. The biggest assumption peer-to-peer lending works off of is that people will be less likely to default on their loans if there somehow exists a personal connection. It’s a shrewd capitalization on a person’s innate sense of honor, magnified by personal connection, whether that connection is based off mutual community, existing personal relationships, mutual interest, or geography.
Arriving in the U.S. in 2006, peer-to-peer lending began picking up its pace in 2007, its main known advantage is its ability to lend out with minimal interest rates, usually under ten percent. Unfortunately, that major point of attraction is beginning to gradually fade out with the sheer volume of people beginning to turn to this innovative lending method – making now the optimum time to use it if you’ve been considering it, before it fades into yet another financial institution little different from the ones already in existence. The most well known peer-to-peer firms are Zopa, Prosper and Lending Club, all of which have undergone their fair share of both criticism and praise. As a potential investor, one of the risks of offering your backing is put very eloquently in an article by Mark Gimein, business writer for the New York Times: “ultimately a paradox of lending is that the people who are more likely to repay are those who don’t need the money.”
Have you found social lending to be practical? Or is it more of an ideal? What other alternative lending methods have you found to be successful?
Small businesses need to step through the uncertainties. Work on increasing sales. Inflation is already here. We are paying more now for our purchases. So increase prices now. Here’s how to do that, for example: If your health care costs are 5% of sales and you expect (or assume) that these costs will increase 20%, that puts health care costs at 6% of sales; the bottom line result is a 1% decrease in margin; to make that up, increase selling prices by 1% to keep pace. Continue to apply this technique to other cost items. Remember, “a penny makes a difference”. A 1% improvement in margins for $10 million in sales is $100,000. That is big-time money! CFO-Pro says “Walk right through that fear! You’ll feel a lot better. Don’t wait to figure out what the government is doing. They will never get it right! Now–what are you going to do?”
There have been several in-depth studies that analyzed the financial performance of hundreds of companies around the world. Insights were provided by these companies into the key metrics and strategies used by the best performers. The following were found to be the most sustainable value creators, and where focus is concentrated in those companies successfully creating value. The key numbers to watch are:
- Net income
- Cash flow from operations
- Total assets
- Total liabilities
- Total equity
Using these six key numbers, four ratios are tracked and trended:
- Asset turnover (revenue/assets)-the higher the turnover, the better utilization of assets experienced.
- Profit margin (net income/revenue)-the greater the margin, the more profits available to fund growth.
- Cash-flow yield (cash flow from operations/net income)-the higher the yield, the more success enjoyed in managing working capital (ie., current assets minus current liabilities).
- Debt-to-equity (total liabilities/total equity)-the higher the ratio, the more of other peoples’ money (leverage) being used to finance growth.
Successful organizations do well on all these numbers. If you are not doing well on the ratios, then drilling down into the six key numbers is needed.
The entire management team needs to understand how the ratios and underlying key numbers connect to value creation.
Standards of performance can be created by looking at historical numbers over time, which will reveal ranges and trends. Then look for comparable measures within your industry to see how you fare against industry peers. Follow this up by setting some annual targets for 1 to 5 years. In other words, “do what the big dogs do” whether you are local or national in scope, and whether you are for-profit or not-for-profit.
This sets the discipline for making good decisions with the goal being to achieve outstanding long-term return on investment.
Your present performance measures may have defects; and there may be no quick remedies. CFO-Pro can provide a strategic perspective on your financial performance measures. If you are interested in connecting the strategy of your company with the financial reports, and to speak to how your company intends to create value, please contact me directly at firstname.lastname@example.org or 630-269-7646.
You are in your car and suddenly you find the two-lane highway narrowing to one lane. Traffic flow slows to the pace at which two lanes of traffic can merge into one. Your speed of 60 slows to perhaps 20 and can even be a stop and go to move ahead one car length. This is a bottleneck.
Bottlenecks are occurring everywhere in the business world. Bottleneck in business happen in the processes employed in every business. They happen in production, distribution, fulfillment, billing, filing, etc. They happen in manufacturing companies, distribution, retail, construction, real estate, consulting, financial services, and service businesses of all kinds. Bottlenecks are rampant in non-profits, and in government and the bureaucracies they employ.
I believe the primary culprits that cause bottlenecks are these:
- Inadequate infrastructure—capacity has topped out
- Inefficient processes—the quantity of raw material (or data) processed in a given time, known as ‘throughput’ has topped out
- Poorly trained workers—individual production has topped out
Capacity constraints affect a company’s ability to grow. Firms that find themselves bumping up against their system’s capacity constraints soon find that growth has stopped; profits begin to decline unless expenses are cut accordingly.
Any part of your business that has a capacity bottleneck will find the production and efficiency of everyone reduced to the speed of throughput at the bottleneck. The operation will slow to the lowest common denominator—the productivity at the slowest part of the process.
For example, if a bottleneck is reducing throughput by 30%, and your customers are unwilling to wait in line, your sales levels could be 30% lower than what they should be. How much margin are you losing at the bottleneck? If your normal throughput is $1,000,000 annually and the bottleneck reduces it by 30%, you have a new sales level of $700,000. At a gross margin of 60% applied to the lost sales of $300,000, the lost profits amount to $180,000! And this is just a one million dollar organization!
Worse yet, are you paying for “stand around” time while the under performing parts of your process “catch up” to the rest of your production?
What could you do with the money that you are leaving on the table?
As for the government bottlenecks, they just seem to throw more people and money at it without addressing the three culprits. And you and I are paying for this bad practice as government and bureaucracies have become the largest employer of record throughout our entire economy!
If you are concerned that your business is leaving money on the table due to bottlenecks, and want to quantify the expense and explore alternative solutions, please contact me directly at email@example.com or 630.269.7646. I’m available to discuss options to unlock the revenue and increase cash flow.
In past newsletters we’ve focused on finance, marketing, getting out of debt, sales, and establishing a sustainable growth rate, so it’s time to look at your product line. For some, the statement “more is better” sums up their philosophy on an effective and profitable product line. But that mantra is missing a key word: profit.
To maximize your resources and profit, regularly review your product line and note your low-profit-margin items. Continuing to carry low-profit-margin items in your product line will depress your profits and hold your potential profit margin down. Typically, these items use up valuable (and perhaps limited) resources that could be more profitably used elsewhere.
Tom Monaghan, founder of Domino’s Pizza, tells this story about his first pizzeria:.
“One night, most of my employees didn’t show up, and I didn’t know whether to open or not. Someone said, ‘Why don’t you just cut out the six-inch pizzas?’ We had five sizes, but most of our business was the smallest, the six-inch. It took just as long to make as the big one and just as much time to deliver, but cost less. We never got busy that night, and yet we made 50 percent more money than we ever had. The next night I cut out the nine-inch pizza, and all the bills caught up. I learned then that keeping things simple could be more profitable.”
Business owners should continuously ask themselves two questions:
- How do I increase my business’s most profitable activities?
- Is it really worth it to maintain the low-margin activities?
Sometimes a business owner can be too involved in the daily operations to find the time for review and evaluation of their product line profit.
CFO-Pro can help business owners sort out the low-margin items.