Quick Guide To Knowing Your Crucial Numbers
Vince Lombardi was considered by many to be one of the best NFL head coaches of all time. The Super Bowl trophy is named after him. And whether you like American football or not, many of his strategies and principles are applied in business today.
For example, Lombardi was famous for going into the locker room with all the professional players on his team waiting for his presentation on the first day of spring training.
He would start by holding out his hand with a football in it and say, “Gentlemen, this is a football.”
And he would drill the basics into the team. Over and over again. It paid off, as he never had a losing season in all the years he was a head coach.
The basics for entrepreneurs are in the financials.
Of the 4,000 or so entrepreneurs I’ve worked with over the years, more than 80% of them fail in understanding the basics on financials in small business.
Some of these entrepreneurs have $10-20MM companies.
Yet the amount of sales they make doesn’t help them, if they don’t understand their core financials. They all end up struggling.
Banks, investors, sometimes vendors all require seeing them.
It’s like walking into a packed storage room with the lights off.
There’s a much easier way.
Three financial statements you MUST understand:
1. Cash Flow Statement—how much cash you have.
2. Income (Profit and Loss) Statement—are making money or not.
3. Balance Sheet—how much your company is worth.
Cash Flow Statement
Just like your checking account. All it cares about is how much money goes in, and how much money goes out.
Examples of Cash In: sales, investment, loans, grants, robbing a bank….
Examples of Cash Out: expenses and expenditures. Expenses: those things that you spend to run the company day-in, day-out. Things like rent, payroll, utilities, and so on.
Expenditures: those one-time purchases you need to make for the business. Things like delivery vans, new computer system, setting up your corporate structure, and so on.
Income (Profit and Loss) Statement
“What’s the bottom line?” and “Are you in the black or red?” come from this.
The P&L shows you if you are profitable by only looking at your sales (minus your COGS or COSS—Cost of Goods Sold or Cost of Services Sold). That gives you a gross profit.
And from your gross profit, you pay all your expenses (not expenditures).
For example, a business sells a couch for $1,000 to a customer.
But it cost them $600 to make the couch.
Gross Profit: $1,000 – $600 = $400
This business now can pay all their expenses (rent, payroll, utilities, etc.) from this Gross Profit (of $400).
The question becomes this: how many $1,000 couches does this business need to sell to pay all their monthly expenses?
This business adds up all their monthly expenses and they total $15,000/month.
OK, if each couch gives them a gross profit of $400, how many do they need to sell to come up with $15,000?
Breakeven = Expenses / Gross Profit
Answer: $15,000 / $400 = 37.5 couches
So, this business needs to sell 38 couches in a month to breakeven. Anything they sell over this amount, they are “in the black” or profitable.
What you own minus what you owe is how much your company is worth.
Assets – Liabilities = Owners Equity
Assets = cash, accounts receivables, inventory and so on. Liabilities = outstanding loans, accounts payable, payroll taxes, etc.
The difference between the two is what you and your shareholders own in the company.
A test for you to answer now: If you are profitable (i.e. your P&L shows you’re in the black), can you run out of cash (i.e. your cash flow goes down to 0)?
If you answered “Yes”, you are correct.
How can this happen? If you’re company is profitable, how could you run out of money?
The answer is simple, and what many entrepreneurs mess up, and then either struggling financially, or even worse, go out of business.
How you manage your expenditures.
In our example, the furniture maker is now selling 45 couches a month, giving them a monthly profit of $2,800 (couches 39-45 at $400 gross profit).
But the entrepreneur doesn’t understand his financials very well, and only sees the $45,000 in his account (45 couches x $1,000 each). So he buys a new machine to make couches more efficiently for $25,000.
Then when he pays monthly expenses, he realizes he doesn’t have enough money to cover everything.
In reality he now has negative cash flow of $22,200 ($2,800 profit to pay a $25,000 machine). Oops!
Most businesses go out of business because of this.
The more you know about your financial statements, the better you will manage your cash and not have surprises like this.
And even start to really grow your business successfully.
Action Steps for the Week
Create a Cash Flow Statement spreadsheet to forecast out the next 12 months of your business.
Use this sample. If you go “negative”, where can you adjust to make sure you have enough cash?
Do this before doing the P&L statement.