The most important step in running a business!

When we think of running a business, we think of providing the best service(s) or product(s) to our customers. That is the first step in building a strong business, without that step you wouldn't be in business, right? Now the next step is to collect your leads/customers and gain traction by inviting customers to buy your service(s) or product(s) using marketing strategies like Google ads, advertising, blogs and social media post and, why not, Tiktoks. Once your business has gain momentum and sales starts coming in, what's next? Maybe you want to hire staff to help you run the operation side of your business, build relationships with suppliers, increase efficiency in supply chain management, manage your projects and/or maybe increase client retention. For some business owners, these are the important parts of running a business as they are the building blocks of a successful business. This is not always the case. When looking back at what your business needs and what you want, there is one common mistake most business owner do before taking on new decisions, they forget to look at their finances. The finance aspect of the business can be controlled easily at first, you see cash coming in and you see cash going out, simple as that, but as the business grows, the more there are transactions, the harder it become to keep track of them all. That's when it all start falling apart. You want to hire staff because you are overwhelmed, you need to buy parts as you are running low on stock or maybe you need a new truck as the repairs are getting to expensive on the old one. You need those things to keep going, right? You think you have the money to take on those new purchases as you see it in your bank account, but what happens if your business is not profitable and all your money comes from loans, advances or suppliers? Also, what about the timing in spending money? You may have money now to buy what you want, but you may have forgotten something as simple as an insurance payment. If you go ahead and spend and then the insurance payment bounces because you do not have enough money to cover your payment, clearly you are making decisions blind. This is where performance management comes in. Performance management will help you to take control of you business. It will provide you with tools you need to make the required decisions to keep your operations going or to invest. This will be the most important step in running your business, to analyze your finance.

There are three main tools to give you that edge you need to manage your business. First, you'll need internal financial statements, then a budget and key performance indicators to give you objectives to reach.

INTERNAL FINANCIAL STATEMENTS

The first and most important piece to help you analyze your finances are the internal financial statements. They give you past information so you can make future decisions. They are composed of two main statements, the income statement and the balance sheet. Note there is more to those two statements, but for now, to keep this simple, we will focus on those two.

Income statements

The financial statements are composed of an income statement where you get to see the total sales minus the costs of running your business. This will give you the income before tax. If you think you have the skills to calculate the taxes you can add the tax to gain visibility on the earning after tax helping you gage how much tax you are required to pay at the end of the year and get a feel of how much money you really made from your operations. As a starter, this will provide the information you need to increase sales or reduce costs.

As an example, the use of the income statement is as follow: Let's say you have a net earning after tax of 4,000 $/month. You are looking to hire a new employee to help you increase the output of production. If you hire this staff, you will increase sales by 3,000 $/month but this employee will cost you 5,000 $/month. With this information, you know at this moment you make 4,000 $/month of profit, right? You know this employee will cost you 2,000 $/month (3,000$ in sales - 5,000$ in labor = a loss of 2,000$), right? Therefore, after taxes, you will have a 2,000 $/month profit (4,000$ current profit - 2,000$ of loss). Even though you're loosing profit of 2,000 $/month you are still profitable, letting you make the decision to take on a new employee. Because you see the impact of your decision, it will be easier to hire or not the new employee. The decision will probably be made on how much you really need this employee. One thing not to forget when making decisions is the non financial aspect of the decision. We will only touch quickly here so you have a feel of the importance of non financial decisions. Going back on my example, let's say you do not take on this new employee you loose 5 new costumers. Five new costumers that could potentially be recurring costumers. That is, five happy customers that provides you with 5 star rating on Google that gains you 10 potential sales. Would this help you make the decision to hire an extra employee even though your profit stumbles? This is the importance of looking at financial and non financial data. Sometimes the non financial aspects out weigh the financial aspects.

Balance sheet

The balance sheet provides you, on a specific date, what you have, the assets, what you owe on those assets, the liabilities, and what you own on those assets, the equity. In accounting, we look at the balance sheet as an equation Assets = Liabilities + Equity, that means what you have should equal what you owe and what you own or if you prefer Assets - Liabilities = Equity what you have minus what you owe is what you own. One of the main objectives of the balance sheets is it helps you understand what you owe and if you have enough resources to pay for what you borrowed. As an example, let's say you have 40$ in your bank and you owe 60$, then you don't have enough resources to pay what you owe. Therefore, as a decision maker, you will not borrow any money until you have enough cash to pay your debts.

As a rule of thumb, you can't just rely on one set of financial information to make a decision. You need the whole picture. You need to know if you make money from your operations and if you have enough resources to pay your debt, if this is the case.

BUDGETS

We've discuss the need to have internal financial statements, now, you need a tool to navigate decisions you make now to see the impact on the future. Although budgets are a bit complexes in nature, what's important to know is the data that will be used to compile the budget has to be as accurate as possible, but don't worry if you are not accurate at first, budget is an art and takes time to get it right. The more experience you have running your business, the easier it get's to make the perfect budget.

The goal of the budget is, as I mentioned before, to see the impact of the decisions you make now on the future of the business. So let's say you know sales will increase by 5% and your cost will go down 2% next year. If this is the case, when the time comes to make decision on spending you will try your best to follow the budget to meet your expectation. It may not play out as you planed, but you will try your best to match what you've budgeted. If you do, then you will have increase profit by 3%. That 3% will be the fruit of your decision making. There are cases where you couldn't foresee costs, the fact that you know there is a 5% increase in sales, can reduce the stress of unforeseen additional costs. At least you have an overview of your spending when using your budget.

To increase efficiency, the best way to use the budget is to compare it to the actual financial statements. When comparing the actual numbers to the budgeted numbers, you get to see if you where inline with what you expected. If you're off, then you can always add extra effort to get back inline or brace yourself for what's to come.

KEY PERFORMANCE INDICATORS

Key performance indicators are really useful to help you run your business. You need them to give yourself objectives and to benchmark. You can have all types of indicators to help you manage your business, but they have to be useful. If you give yourself an indicator that is useless, then you're just wasting your time on that indicator.

As an example, let's say you want a gross margin (sales minus cost of goods sold) of 50%, if you give yourself that objective to pursue you will try your best to reach your goal, but what happens if your competition has a gross margin of 65%? Then you know there is something that your competition does better than you, therefore you will react to this information and find the best way to match or surpass your competition.

These indicators are mixed in you financial statements and your budget. They are there to guide you and help you make decisions.

To recap, the most important step in running your business is to analyze your finances. There are three tools you should always use, one, monthly internal financial statements, two, prepare a budget and compare it to your financial statements and finally, three, using your key performance indicators, see if you are performing as per you goals or your competition. Any variance from what you've expected has to be dealt with so you can get inline with your objectives. It's sad to say, but your business is like your health, when you are out of line you have to follow a diet, well, it's the same for your business. Having a strict regime will help you reach those goals.