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Introduction

Small businesses are the engine of the North American economy, and people like Joe and Becky (our case study), with no formal business training, run most small businesses. Many business owners believe that bookkeeping software like Simply Accounting and QuickBooks will magically prepare and analyze financial information for them. Because the owners lack basic accounting skills, they are unable to analyze their business results and have no idea what’s working and what’s not. These businesses tend to languish and eventually die from neglect of analysis.

Case Study

Joe runs a local plumbing business along with his wife, Becky. The two of them work hard and are reasonably successful. Joe works from 6 a.m. to 8 p.m. most days and is on call the rest of the time.

If you asked Joe, he would tell you that his major problem is that he gets up, goes to work, comes home, and goes to bed without ever stopping to analyze his business. Am I making money? Am I retaining customers? Am I compensating myself appropriately? The few times he has pondered these questions, he became frustrated and gave up quickly because he did not know how to measure or track his business results.

Financial Management 101: Get a Grip On Your Business Numbers is the second book in the Self-Counsel Press Numbers 101 series aimed at small business owners. Here you will find clear, down-to-earth guidance to help you understand what your company’s financial statements are telling you, as well as solid tools to help you run your business more profitably.

The book is written in an easy-to-digest manner that caters to busy entrepreneurs. It contains a blend of instruction and illustrated examples following the story of Joe’s Plumbing, a typical small business that is run by Joe and his wife, Becky. Joe’s Plumbing faces all the problems that most small businesses face: bad record keeping, uncertain cash flow, and a low profit margin.

The information in Financial Management 101 has been honed from the entrepreneurial seminars, radio broadcasts, and one-to-one training sessions I have done in my accounting firm over the years.

How to Use This Book

Financial Management 101 walks you through the various aspects of understanding, measuring, and monitoring your financial results. You don’t need to read the book in sequence; you can skip around and read it in chunks, absorbing the information that’s relevant to you. I do, however, recommend that you eventually read the entire book as it sheds new light on many old subjects. You may find yourself looking at your financial statements differently from now on.

The book provides sound management advice for all small businesses, no matter what country you operate in. The information is not directly related to any particular set of accounting rules or tax laws. Terminology may differ from country to country, and the dollar signs for some readers should be pounds or rupees or lire, but the underlying principles of this book are universally applicable.

There are many downloadable tools and other useful information at www.numbers101.com. Please surf by and download templates, screen savers, and other cool tools — and sign up for our newsletter while you’re there.

Financial Management 101 is the second book in the Numbers 101 for Small Business series. If you want to brush up on your accounting basics, you may wish to read Bookkeepers’ Boot Camp, the first book in the series. It covers the essentials of record keeping for small business and why it’s necessary to track information. The book also teaches you how to sort through the masses of information and paperwork in your business, how to record what’s important for your business, and how to use that information to grow your business for success.

Your Business: What Is It All About?

How do you look at your business right now? What is it there for? If you are a shoemaker, you might say that the purpose of the business is to provide shoes to customers at a reasonable price. That is your company’s positioning strategy.

The underlying purpose of any business is to make money for its stakeholders. Who are the stakeholders? They are the investors in the business. In the case of small business, that’s usually the owner/manager, but it could also include outside investors.

The only way for any business to make money is to increase its net profit, cash flow, and return on investment at the same time.

Net profit

Net profit is simply what is left after you have deducted all your company’s expenses from its revenues. You can increase your net profit by increasing revenue or decreasing expenses.

Example:
Revenue	$50,000
Expenses:
Cost of goods sold	23,000
Wages	12,500
Rent	9,000
Office supplies	470
	44,970
Net profit	5,030

Cash flow

Cash flow represents all the cash that comes into your business less the cash that goes out of your business.

Cash comes in from such sources as —

• cash sales,

• the collection of accounts receivable,

• new borrowings or investment, and

• cash received from the sale of equipment.

Cash goes out of your business to —

• pay your accounts payable,

• make debt repayments,

• purchase new equipment, and

• distribute profits to the owners.

Example:
Cash in:
Cash sales	18,500
Receivables collected	12,500
Proceeds from sale of machine	8,250
	39,250
Cash out:
Payment of payables	23,275
Loan repayments	6,500
Dividends paid to owner	12,500
	42,275
Net cash flow	(3,025)

Although the above business is making a positive net profit, the actual money is flowing out faster than it is flowing in. This business would find itself in a cash flow squeeze very quickly.

Return on investment

Return on investment (ROI) is the amount of net profit the business makes, shown as a percentage of how much money the stakeholders have invested in the business. Remember that the stakeholder is usually the owner/manager.

For example, let’s assume that when you started your business, you made an initial cash investment of $50,000 and you have not had to invest any further funds in the business. You could have taken that $50,000 and put it in an investment certificate yielding 5 percent. If you had done that instead, you would have made $2,500 every year:

$2,500 ÷ $50,000 = 0.05 = 5%

Your return on investment on the investment certificate then would be 5 percent.

However, you didn’t invest in the certificate, you invested in your business. So how do we look at the roi on your business? In exactly the same way. You’ve invested $50,000. Your business generates $7,550 in net profit annually. Your roi is:

$7,550 ÷ $50,000 = 0.15 = 15%

Therefore, the same $50,000 would generate an roi of 15 percent when invested in your business versus 5 percent in an investment certificate. This is a useful way of evaluating your investment in the business and seeing how your investment return changes from year to year. We will discuss investment return in more detail in Chapter 12.

Let’s move on to Chapter 1 and take a quick refresher course on the reports that make up your financial statements.