Like most of my clients, I am not an accountant and have had to learn a simple method of looking at all those numbers. As I mentioned last post, many small business owners do not use their financial statements because they do not know how. In this post, I will suggest a simple method of looking at financial statements for non-accountants.
Step one. Get a monthly profit and loss statement, also called an income statement, and don’t panic.
Step two. Look at the left hand column of accounts and pick the three or four that you have any control over. They will be unique to your business, but there are usually only three or four. These are typically Total Income, Cost of Goods Sold, Payroll Expense, and Profit. For now, ignore the rest.
Step three. Compare each of these four numbers to what you expect them to be. For example, with the income in a seasonal business, compare the number to last year’s sales for the same month. If the sales are up and that is what you expected, great. If they are off, why and what can you do about it. For the rest of the numbers, it sometimes helps to look at the number as a percentage of the total sales. So for example, if your Cost of Goods Sold usually runs 32% of total sales, and this month it was 40%, there is something wrong. Find out what. Do the same for the other two numbers.
You are done. Well, not really. Now the real work begins. If the labor costs are up significantly, what can you do about it? If sales are flat, do you reconsider that next order?
The key to using the financial statement as a management tool is focusing on the numbers that you can do something about. For most businesses, most months, that means that you can ignore most of the numbers on the financial statement. That does not mean that you do not care about the cost of insurance or the cost of your rent, but as a practical matter, you can’t do anything about it. But you can and should stay on top of those three or four things that you can do something about.