Real-World Finance101 for Small Business (with Professor Frank)

Real-World Finance 101for Small BusinessA few basics and a few things you probably didn’t know

Agenda• Performance analysis• Accounting vs. Finance• Accounting cycle• Roles• Software• Chart of accounts• Accrual accounting• Management cycle• Financial management

What are your numbers telling you about your biz?

• Too fast when margins are shrinking• Too slow when not keeping pace with

markets• Fat when there is no leverage • Vulnerable when revenues are erratic

Trends to Watch

Revenue

Expense

Unhealthy

Time

$

Revenue

Expense

Time

$

Revenue

Expense

Time

$

Healthy

Revenue

Expense

Time

$

Revenue

Expense

Time

$

Trends to Watch

Revenue

Industry Benchmark

Unhealthy

Time

$

Healthy

Revenue

Time

$Industry Benchmark

Trends to Watch

Revenue

Cash

Unhealthy

Time

$

Revenue

Cash

Time

$

Healthy

Revenue

Cash

Time

$

Revenue

Cash

Time

$

Trends to Watch

RevenueCOGS

Unhealthy

Time

$

Healthy

$

Overheads

RevenueCOGS

Time

$

Overheads

Revenue

COGS

Time

$

Overheads

Trends to Watch

Revenue

Unhealthy

Time

$

Healthy

Revenue

Time

$

Benchmarks

What we see financially is that…• Business owners don’t know when they

are off track• Opportunities go unnoticed• Markets fluctuate – its hard to ride a

wave when you aren’t looking

Accounting vs. Finance

Accounting

• Looks back• Tax driven• Transactions• Internal data• Cycles – mo/qtr/yr

Finance

• Looks forward• Plan driven• Models / scenarios• Internal plus external data• Management cycles

Finance is about combining accounting information with business intelligence

Accounting Cycle

1. Daily posting

2. Monthly closing1. Reconciliations (balance against bank

statements)

2. Adjustments (accruals and

3. Reporting

3. Annual closing

Role of Bookkeeper

• Posting• Reconciliation• Billing• Basic financial reporting

Principle of “Separation of Duties”

One person should not manage the books and handle receipts and deposits

Accounting Software

Selection Checklist:

Is it easy to use & get help? Does it interface with my

operations management system? Association or peer network

preferences Cost of systems & ops Is there a hosted version?

Regional leaders:

US and Canada: 1. QuickBooks Pro2. Microsoft Dynamics

Europe3. Sage Peachtree4. MAS

India5. Tally

Australia and Pacific Rim6. MYOB7. Zero

Chart of Accounts & LOBsChart of Accounts: The naming convention for grouping accounting activity.

Lines of Business (LOB): are the tributaries to group the sources of revenue and expenses.

Example: • Products• Services• Special projects

Achieve a balance between: 1. Minimal detail for easier management2. Granular enough for visibility on financial

performance by LOB.

Where is your revenue coming from?

Where is your profit coming from?

Chart of Accounts

Two categories of accounts:

1. Balance Sheet accountsRunning totals; account balances as of the end of a reporting period.

2. Income Statement accountsPeriod activity totals; total amount of activity during a reporting period.

Chart of Accounts

Assets

Current assets

Cash/checking

Accounts receivable

Inventory

Long-term assets

Furniture/equipment

Organization costs

Liabilities

Short-term liabilities

Credit cards

Accounts payable

Long-term liabilities

Long-term loans

Equity

Capital stock

Retained earnings

Balance Sheet

Assets = Liabilities + Equity

Chart of Accounts

Sales

Cost of goods sold (COGS)Product costs

Service costs

Gross Profit (Gross Margin% = gross profit/sales)

Expenses (a.k.a., SG&A, sales, general and admin)

Salaries

Benefits

Incentives / bonuses

Rent

Legal

Operating Income

Other Income

Net Income Profit% = net income/sales

Income Statement(a.k.a., P&L; profit & loss)

Principle of Revenue and Expense Recognition (GAAP)

• Revenue received before it is earned should be booked as a prepaid asset and not recognized as income until it has been earned.

• Expenses owed but not paid should be recorded as expenses in the period incurred regardless of when they are paid

Accrual Accounting

• Accrual-Basis Accounting: revenues and expenses that have been received and paid in cash plus revenues and expenses that have been earned and incurred• Accounts payable or receivable, depreciation

• Cash-Basis Accounting: revenues and expenses that have been received and paid in cash • Cash payments and receipts

Accrual Accounting

Your choices:A. Accrual Basis B. Cash BasisC. Combination

Most small businesses choose “combination”– Pay taxes based on “Cash Basis”– Management reporting based on “Accrued

Revenue” and “Cash-based Expenses”– Financial analysis based on Full Accruals

Adjustments

• Depreciation and amortization– Recognizing expense in the period where you

use it. Can impact analysis if not reflected.

• Accrued earnings– e.g. Multi-month projects

• Accrued expenses– e.g. prepaid software license, contractor

payments

Maybe you didn’t know…

• Balance Sheet doesn’t reveal the market value of a business – If you were looking to buy or sell a business, assets

and liabilities don’t tell the story. Value is driven by trends, future potential, market comparables, ability to generate “free cash”.

• Income Statement (P&L) does not reveal where your business is headed – Trend analysis tells the bigger story– Performance analysis tells the detailed story

Financial Management

• Business planning• Goal setting• Budgeting• Progress analysis• Communications to management team

– Goals– Actual performance– Collaboration on needed improvements

• Monthly, quarterly and annual cycles

Financial Management Resources

• Professional association standards or recommendations

• Integrated systems (financial and operations)• Financial dashboard (“business intelligence”)• Business advisor / consultant• Board of directors or advisory board

Performance Analysis

Trends

Goals Benchmarks

Ratios

Performance AnalysisCombined Business Analysis: growth, profitability

Line of Business (LOB) Analysis: growth, profitability

Services

GrowthGM

Profitability

Product Sales

GrowthGM

Profitability

Other

GrowthGM

Profitability

KPIs (key performance indicators)

• Ties operating data to financial data• Example – product sales and service

– Revenue or Expense per employee– Quick Ratio (Current Assets / Liabilities)– Support calls per sale– etc.

The Process

• Need to do it every month• Don’t let it take too much time (30 min

monthly management)• Use analyzed data to find “the big 3

priorities”• Share with your team – get everyone on

the same page

Getting your Team on the Same Page

How do you know when you’ve “got it?”

Checklist for success: Taxes submitted on time

(not too much, not too little)

Goals are set & tracked Routine monitoring BI shared with team Course-corrections Tools to monitor

Long Term Goals

• Sustainability• Long-term growth• Market position• Owner’s return on investment (ROI)• Equity value• Liquidity event (sell, acquire, investment)• A good night’s sleep

Don’t live on an island!

Free Financial Health Check

Your Company, Inc.

https://healthcheck.corelytics.com/pub/sign_up.aspx