Police Your Own Business!
Three Things to Watch for That Could Get Your Business Issued a Warning Ticket
Chia-Li Chien | March 03 2011
It was a sunny, early spring day and we were on our way to the North Carolina Zoo. While traveling on Highway 49 and enjoying the scenery, we noticed a state trooper. Sure enough, as soon as we made eye contact, we got pulled over. The officer asked my husband T.C. why he was not wearing a seat belt. Well, due to his torn left shoulder, he wore it differently. The state trooper collected his information while we waited silently in the car with T.C.’s favorite NPR show “Car Talk” now turned off. The trooper came back with a warning ticket and informed T.C. that unless he had a doctor’s order, he must wear the seat belt the correct way, meaning visible and not under the arm. It was a relief that T.C. just got a warning ticket, nevertheless, it’s on his driving record now.
In small business, no one polices your business, not even the IRS. Your CPA and the IRS don’t really care whether or not you make a profit, although if you do make a profit, you may end up owing them more money. But they don’t serve as your “cash police.”
How often have you wondered, “how come there is no cash in the business checking account?” Here are three warnings to be aware of if you want your business to continue to create value. Remember, no one is policing your business but you.
1. Negative Net Profit – Perhaps you don’t know your net profit until your CPA completes your tax return. I would say that all of my clients do check their profit and loss (P&L) statement on a monthly basis. If you don’t, you should get in the habit of checking that P&L on a regular basis to know whether or not you are running your business with a positive net profit. If you are, congratulations, but if you are not, you just got yourself a “warning ticket.” Analyses are needed before you slash expenses. You might want to start by looking at which product or service can bring in more net profit. Or look at which customers are more profitable than others and why. Often time, increasing company revenue is the best way to get in the black. However, positive net profit does not necessarily mean you’ll have cash in your business checking account, especially if the business is carrying a huge debt that may or may not show on your P&L statement.
2. Negative Cash Flow – While you are checking your monthly financial statements, you might want also to check your cash flow statement. This tells you how much cash you have on hand. If you have negative cash flow for a while, you may begin to feel like you are running on a treadmill. Borrowing working capital from the bank or an infusion of investment capital may not solve the problem. Cash Flow Formula:
Net Profit from Business
+ Accounts Receivable at Start
- Accounts Receivable at End
+ Inventory at Start
- Inventory at End
+ Accounts Payable at End
- Accounts Payable at Start
+ Cash from Assets SOLD
- Cash Paid to Purchase New Assets
- Debt at Start
+ Debt at End
= Cash Flow
By looking at this formula, you can see there are many variables to determine cash flow. For example, you might have positive net profit, yet a huge amount of accounts payable on large outstanding debts. It will be hard to breathe if your business shows a positive net profit, but has very little cash or even a negative cash flow. If you have negative cash flow, your business just got another “warning ticket.”
3. Not enough Return On Investment – Take the business net profit divided by total assets and you get your return on investment (ROI). Have you done this calculation for your business yet? There are many industry benchmarks you can compare to determine if you have adequate ROI.
There are two other types of ROI:
Product ROI = Gross Margin / (Average Inventory + Average Accounts Receivable)
(of that particular product)
Customer ROI = Average Accounts Receivable / Gross Profits
(of that particular customer)
Obviously, you must have GOOD financial data in order to analyze your business. Sometimes it may take up to an entire year to get data clean enough to accurately complete the above analyses and avoid those “warning tickets.” Your CPA may provide such a service on a regular basis for you. If this is very foreign to you, hire a fractional or virtual CFO (Chief Financial Officer) for your business to monitor these vital signs on a monthly basis. That CFO is your safety belt, there to make sure that you not only avoid any “ warning tickets” that go on your record, but also to make sure you don’t endanger yourself and others while on the road.
As a business leader, you’re not only responsible for you and your family, but also people whose families rely on you. So be aware of the warning signals and make sure you are enjoying the ride and not attracting the negative attention that might get you a “warning ticket.” This is fundamental in building value for your business.
Chia-Li Chien, CFP®, CRPC, PMP; helps entrepreneurs to creating business value that transforms their world. She is the author of Show Me The Money and columnist for WomenEntrepreneur.com & Fox Business online. She is available for consulting, speaking engagements and workshops. She can be reached at http://www.chialichien.com or email@example.com.