2004 Financial New Year Resolutions

A couple of weeks ago you received the 2004 Small Business New Year Resolutions that I thought we should consider this year. Unfortunately, I only had room in that piece to identify the resolutions, but not to discuss why they're important, or how to accomplish them.

Consequently, this article is the first in a series where we'll cover the hows and the whys of the 2004 resolutions in each of the seven categories.

Resolution One: I resolve to focus more on financial operating fundamentals.

Business owners must always be diligent in the financial management of their business. There are too many financial operating fundamentals to list all of them, but here are a few critical examples:

• Stay close to the quantities, line distribution, and age of your inventory.
• Stay closer to your Accounts Receivable aging report.
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• Become one with your expense management and Accounts Payable.
• Learn how to calculate your A/R days and A/P days, understand their relationship to each other, and how that relationship affects your cash and capitalization requirements.
• Track your sales-to-expense ratios as the fiscal year progresses, so you know if, when, and how much you should adjust spending.

Even if you've hired someone to manage these areas on a daily basis, remember this: You cannot delegate the ultimate responsibility for your business's financial performance.

Resolution Two: I resolve to do a better job of managing my company financially with regular and accurate financial statements.

After spending several years as a business consultant, I'll wager that less than half of small businesses consistently produce regular (at least quarterly) and accurate profit-and-loss statements and balance sheets.

If you're in that group, and the only financial report you have is the P&L and Balance Sheet you get once a year with your tax return, using that information to manage your business is like making a salad with 15-month old lettuce. In either case, what you're working with is rotten.

With all of the electronic accounting capability available today, there is NO EXCUSE for EVERY small business not to be producing and managing with current numbers. These programs cost as little as the price of a dinner for two and anyone can learn how to use them. The direct benefit is the ability to manage your business with fresh numbers.

And a business owner who doesn't use electronic capability to collect, track and manage their business's financial information is like someone eating a meal with their fingers when they know that knives and forks have been invented.

Resolution Three: I resolve to learn more about what my financial records are telling me and, armed with that valuable information, manage my business more effectively.

Remember what the dog said after he chased the car and caught it? "Now that I've got it, what do I do with it?" Now that you've made a commitment to manage with current financial information, and have created your financial records, what do you do with them?

If you're worried that accomplishing this resolution means you have to become a bookkeeper or accountant, stop worrying - it doesn't. But successful business operators must at least understand the flow of the financial components of their business, and their relationships to each other.

I believe business failures could easily be cut in half if anyone wanting to become a business owner were required to pass a course that taught the basics of the relationship between cash flow and accounting, and how to read and understand financial statements.

If sales are up but you're out of cash, do you know how to find out why? It's on the Balance Sheet.

Do you know where is the first place to get an early tip that inventory may be creeping up? It's likely in your Gross Profit Margin, right there in the middle of your P&L.

Do you know where to find why you're not profitable even though you know you're maximizing margins and watching payroll? The answer may be hiding in some of those annoying P&L line items like "Bank charges" and that insidious "Miscellaneous" account.

If you didn't know the answer to these questions, let me tell you how you can solve that problem: Do Financial Resolution Two EVERY month. If you build and use your statements, the understanding will come.

Resolution Four: I resolve to establish a budget for every expense line item on my operating statement, and review budget vs. actual at regular intervals.

Just as there are many things small businesses could teach big businesses a thing or two about, we need to know what we can learn from the big guys. Budgeting is one of those things.

Ever wonder how an international conglomerate keeps track of all of its billions of dollars? How do they make sure they know how much to spend in one of their thousands of divisions, departments, and installations? They do it by establishing budgets, giving each unit theirs pieces of the budgets, and requiring them to operate within those parameters.

Here's an interesting paradox: Big businesses use budgets because they have so much money and it's the only way to manage all their money efficiently. Small businesses should use budgets because we have so little money, and it's the only way to manage our limited money efficiently.

Resolution Five: I resolve to develop a capitalization strategy based more on retained earnings and less on debt.

As long as you are in business, every dollar of retained earnings capital is making you money because it's working capital that you don't have to borrow from the bank, or dilute your ownership with by taking in investors.

How do you retain earnings? It's very simple: By not taking all the profits out of your business for yourself. Employ a little old fashioned deferred gratification.

If you pay your business now with retained earnings, it will pay you later by becoming your safety net during the inevitable period(s) of slow sales or other problems that can befall a small business. Nothing impresses a banker more than healthy retained earnings when you do need to borrow money. And a healthy debt-to-equity ratio will help you hit a financial homerun when you sell your business.

Resolution Six: I resolve to establish a relationship with at least two banks, and make sure at least one of them is an independent community bank.

Every small business needs to have a relationship with at least two banks. The primary reason is because bankers are just like everyone else - they get promoted, change jobs, get fired, and yes, sometimes they die. And sometimes banks get sold or merge with other banks.

If any one of these things happens to the only banker who knows your story, then you've got a problem until you get another banker trained. And here's where fate rears its ugly head: Those things that happen to your bank or banker will most likely happen when you need him or her the most.

So make sure at least two bankers know all about you and that you're doing some business with both of them. It's not even a bad practice to do business with three banks.

The reason I think every small business should have at least one of their relationships with an independent community bank is because typically, this type of bank will put more emphasis on your character and not everything on the credit score their computer spits out. Most small businesses wouldn't make it if someone at a bank didn't give them a way to demonstrate their character and give them credit for it. Only a person can do that. A computer cannot.

Resolution Seven: I resolve to find out how my company's financial performance compares with that of my peers.

Every industry has its own rules-of-thumb for how much a business in that sector should be spending, and how much profit they should be making, all based on sales volume. There are ratios and percentages, produced by aggregating the financial statements of many businesses in a particular industry, for everything from payroll to payables, from inventory to interest, and from debt to deferred compensation.

Industries and financial institutions have been compiling and recording these indicators for so long, in such significant numbers, and at all levels of activity, that they are used every day by sophisticated managers as valid reference points from which to measure their business's performance.

If you want to impress bankers and investors, find out how your company's performance stacks up with your industry peers. Robert Morris Associates is one publishing firm that offers this information. There are others. They don't give it away, but it's not expensive. You can find these publications at your industry trade group, your local Chamber of Commerce, a public library, a Small Business Development Center, or your banker can help you.

Write this on a rock - The more you educate yourself on the financial fundamentals of business, the more you will seek financial excellence for your company. Along the way, you will become a sophisticated and successful manager of your business's financial performance, and you will like the performance trend you see.