In my career as an entrepreneur, I’ve often fooled myself about what’s important and how to build my business. I’d go to work each day focused on results that are easy to see: making a sale, collecting “follows” on social media, tracking the website hits from my online advertising. And sure, all those things are cool — but measuring them rarely leads me to the behavior or the decisions that would make my business more sustainable and more profitable.
So I’ve resolved to stop fooling myself. Instead of looking at these obvious, outward metrics, I have started to listen to far more important internal metrics and ratios like cash flow, gross margin, overhead burden and demand forecasts. It’s a gutsy move — I don’t always like the answers I find when I ask the harder questions — but my business is better for it, and I know that I’m a better entrepreneur for asking.
Want to try it? Every business is constantly communicating these inner metrics through its financial statements. Once you know how to listen, you’ll hear what your company needs and where it’s going. When you’re ready to hear what your business is telling you, start with these 5 steps:
- Come Clean. Business speaks the language of accounting so putting your financial books in order is a vital first step. Hate accounting? Hire a good part time CFO or highly experienced business accountant (not necessarily a CPA, since they tend to focus on tax issues rather than operational metrics) to get the ball rolling.
- Ask for More. Don’t take your financial statements at their face value. Instead, use them to calculate key metrics and ratios. The P&L can tell you, for example, the true cost of sales, the break-even unit sales volume and the overhead burden per sales dollar. From the Balance Sheet, learn to calculate your key liquidity ratios — Days Sales Outstanding, Days Payables Outstanding, and Days Inventory are a good place to start.
- Draw Conclusions. No, really. Draw your financial results on a graph. Plot the changes in key metrics over time, and connect the dots to show the trend line. Trends don’t reverse themselves magically — if the line is going in the wrong direction, it’s time to act!
- Build New Relationships. Ratios based on financial statement basics show you the changing relationship between two key metrics. And that turns out to be both highly useful and highly predictive. Experiment with calculating your own ratios between two related variables and find KPIs that are meaningful and impactful for your business. Need a hand up? A number of great books will get you started, including The Vest-Pocket Guide to Business Ratios.
- Compare to the Competition. Various companies publish “Statement Studies” which aggregate financial results from similar businesses. (Bankers use this for underwriting loans.) Grab a copy of the Sageworks or Risk Management Association data and compare your results to those of similar businesses across the country. Spot your financial weakness and set goals for improvement.
It’s a shame that standard financial statements have evolved into boring, one-dimensional descriptions of a company’s operations. We need to realize that financial statements are not an end result — they are just the starting point for understanding what the company is trying to tell us.
Once you’ve taken the five steps above, you’ll end up with a whole new way of looking at your company. There’s no one set of metrics that will work for everyone, so keep experimenting. And keep charting your results over time. When you do, you’ll find that you have developed a powerful, executive dashboard. All of this starts with standard financial statements, and a willingness to listen to what they are really trying to tell you.
David Worrell is an award-winning entrepreneur and now helps other business owners as a part-time CFO. He is a partner at Fuse Financial Partners in Charlotte, North Carolina, and author of The Entrepreneur’s Guide to Financial Statements. Contact David at [email protected].