Nearly one in five businesses in the U.S. fail within its first year. Want to know the number one reason why?
Cash flow problems.
If not managed correctly, cash flow can be a literal business killer. Keeping expenses down is key, while still channeling resources into business growth. Often, achieving both these objectives can leave you feeling like you're walking a tightrope.
Fortunately, there are almost always ways you can control expenses and drive growth at the same time. And it all starts with getting cozy with your profit and loss statements.
Many new entrepreneurs skim over their financials, just looking for investor-centric metrics. This is a mistake.
Profit and loss statements are one of the most valuable tools for decision-making. They give you a bird's eye view into operations and liquidity.
Let’s take a page out of the experienced executive’s playbook and find out how to make your profit and loss statements work for your business.
Keep Your P&L Statements Up to Date
One of the first tips for making your profit and loss statements work for your business is to keep them up to date. It can be easy to get caught up in day-to-day operations. Before you know it, a couple of months have gone by and you haven't even looked at your P&L.
When you do, you realize it isn't up to date. This can delay key decision-making, leaving you operating in the dark.
To avoid this, you have to make sure that the company books are being maintained throughout the month.
Not only should the company books be kept up to date, but they also need to be reviewed for misreporting. Your accountant should be reviewing the P&L regularly to make sure that everything is being reported accurately.
Inaccurate reporting can compromise the validity of your statements and throw off decision-making. It's also a very common issue. According to survey results, almost seven in 10 respondents revealed that their company had to restate its earnings due to data inaccuracies that weren't caught in the early stages.
Analyze Your Profit and Loss Statements Regularly
Another key practice is to analyze your company's profit and loss statements on an ongoing basis. Like we said above, a lot of entrepreneurs and business owners skim over their financials without really putting them to use. However, any seasoned executive knows that reviewing a year-to-date profit and loss statement once per annum isn't going to cut it.
Doing a horizontal analysis of year-over-year numbers is essential, but you shouldn't stop there.
At a minimum, you should be evaluating your P&L statements at least every quarter. However, if you really want to make them work for you, we'd advise you to refer to them on a monthly basis.
This will allow you to track changes from month to month, forecast liquidity, and nip excess expenditures in the bud.
Compare Your Profit and Loss Statements
Speaking of tracking changes, this is another pivotal way you can leverage your profit and loss statements. Simply viewing the latest P&L won't be very illuminating, especially if you're trying to track growth and expenditures in an actionable way.
Comparing multiple P&L statements (the last three months' history for example) allows you to get a better idea of how your company is performing and helps you spot trouble before it becomes serious. Instead of a single snapshot, you can track growth compared with the same period in previous years. You can also gain tighter control over cost creep, get insights into sales trends, and see where you can increase sources of revenue.
Cash flow statements often get all the credit for liquidity reporting. However, if you want to get a real handle on your liquidity, it can pay to look deeper than your cash flow statements.
Cash flow statements will give you insights into how cash is moving through your business. However, they only reveal what's happening with your cash and cash equivalents – they won't calculate your working capital ratio.
The working capital ratio, also known as the current ratio, is your current assets divided by your current liabilities.
- If you have a ratio over 1, this means that you have enough liquidity to pay all bills on time.
- A ratio of 1.5 to 3 is generally considered an indicator of good company health.
- Anything under 1 indicates that you should take swift action before you run into liquidity issues, such as adjusting invoicing terms.
- Ratios above 3 could indicate that you have excess capital that could be better leveraged.
Identify Key Metrics
Every business is different, which means that every business owner will have specific metrics they want to pay special attention to on their financial statements. Identifying what metrics to keep a close eye on can help you further your business goals and accelerate growth.
At the same time, you should also be looking at industry benchmarking metrics, rates of return, and valuation metrics such as Price to Book, P/E ratio, and EV/EBITDA.
If you aren't looking at these types of metrics, now might be a good time to think of hiring a CFO, even if it's on a part-time or outsourced basis. A CFO will be able to walk you through every detail of your profit and loss statements and help with key financial decision-making.
If you don’t really understand what your P&L is telling you, hire a part-time CFO or financial planner to go over your statements and help you understand how the report relates to your sales, costs, etc. It will be the best money you can spend.
One of the most fundamental ways you can put your profit and loss statements to work is by using it to control expenses. The larger a company grows, the harder it can be to keep expenses down.
For instance, if you're working with numerous vendors, you might not realize when some vendors' prices become less than competitive. The same applies to variable costs.
One way you can get a handle on variable costs through your P&L statements is by looking at past variable expenses and calculating what percentage of sales they represented. You can then use these historic percentages to forecast future costs and as a benchmark to keep them in line with your selling activity.
At the same time, you can use your P&L to crack down on fixed costs. It's easy to get complacent about fixed costs. After all, most fixed costs are essential overheads. But, are you choosing the most competitively priced options?
The thing with fixed expenses is they repeat every month. If you are overspending on fixed costs, this can eat into your annual revenue significantly.
Reviewing fixed costs can be challenging because many involve long-term relationships with suppliers and vendors. However, you should test the market every so often to make sure you aren't missing out on better deals. You can do this by issuing a request for proposal (RFP), or via more informal channels.
Whichever method you choose, this will help you get the word out that you're a company that watches its costs.
Another way you can review and control costs is by investigating upgrades. For instance, if your profit and loss statement reveals that your IT expenditure on servers is rising year after year, it might be time to pivot to a cloud-based solution.
Use Your Profit and Loss Statements to Forecast Growth
Forecasting growth is vital for smooth scaling, and your profit and loss statement is the place to start.
The more accurately you can forecast growth, the better decision-making you can carry out. However, accurate forecasting involves more than just multiplying your revenue for the current period by a specific rate of growth.
The best way to get an accurate prediction is by projecting your profit and loss statement line-by-line. This will give you more detailed insights.
For instance, higher revenues might require you to hire additional team members. This can drive up overhead in a way that's not proportionally to revenue changes.
Don’t Get P&L Tunnel Vision
Finally, don't get tunnel vision when using your P&L to guide business decisions. Ultimately, your profit and loss statement has to work for your business, not the other way around.
In other words, don't fall into the trap of making decisions purely to get better numbers on your P&L.
Revenue growth and well-managed expenses are always a good thing, especially if you're looking to attract new investment. However, there are times when you need to look beyond your P&L to make decisions that benefit the health of your company in the long term.
Expenses related to your company culture are one example of this. Building a positive company culture is one of the most important things you can do for long-term business success. However, you might need to divert resources to this goal.
Fostering an amazing company culture might drive up certain expenses on your profit and loss statement. But this shouldn't deter you from investing in this area. Instead, look for ways you can quantify your investment.
One way you can do this is by including culture among the non-physical and non-tangible assets on your balance sheet. If you're wondering whether company culture belongs on the balance sheet, consider this:
Research shows that company culture can drive 30 percent higher levels of innovation and 40 percent higher levels of engagement.
Leveraging Loss and Profit Numbers to Chart Your Way Forward
Profit and loss statements can give you invaluable insights into your business's growth. By comparing your P&L statements you can track sales trends, identify cost creep, carry out benchmarking, and more.
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