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If
you're a typical entrepreneur, you likely have the confidence, intelligence
and ambition to implement and execute your business plan. And if you have
all those qualities--plus one more essential ingredient--then you have an
excellent shot at business success. The problem is, this one critical
ingredient often gets the least attention. So what is this all-important
ingredient? Having a complete understanding of the numbers that drive your
business.
Entrepreneurs
are, by nature, focused and driven. They're focused on the next product and
the next sale, yet when asked what last month's revenues were, or what
accounts receivable are today, they may only have a foggy notion at
best--even though the financials are the tools that help manage successful
business ventures over the long haul.
For
example, consider the emerging company with sales growing at 10 to 15
percent every month. The company is profitable, but never seems to have
enough cash. A common error in this situation is to continue ignoring the
numbers, and ultimately the business fails because it's strangled for cash.
But
the informed business owner with an eye on the financials can see that if
sales are slowed and the collection of receivables is stepped up, then cash
flow will magically increase. This allows the business to pay suppliers and
vendors promptly and get working capital back to appropriate levels.
So
what are the most important numbers for every emerging business owner to
know? Keep your eyes on these numbers to best manage the financial side of
your business:
Working
capital is the capital you have available to work with today. This is
determined by subtracting current liabilities from current assets. A
rule of thumb says you should have $1.50 to $2 of current assets for
every $1 of current liabilities.
Revenues.
Know your sales on a monthly, quarterly and year-to-date basis. Compare
these to your plan to see if you are behind or ahead.
Gross
profit. Revenues
less the direct costs of producing your product is your gross profit. In
most cases, there should be 50 percent or more of your sales volume left
over after you subtract your direct costs (cost of goods sold).
Profit
margin. Subtract
the total of your general and administrative expenses from your gross
profit, then divide that number by your sales. This number will tell you
how profitable the business is. If the number is negative, you are losing
money. Make sure the number is as good as or better than others in your
industry. If the typical profit margin in your industry is 12 percent and
yours is 5 percent, you are not managing your business as well as your
competitors. Find out what you need to do to improve that margin.
General
and administrative expenses.
There are typically three biggies over which the business owner has a
great deal of control. Know these numbers, and be prepared to adjust them
to the current business environment. They include:
Compensation.
This is often one of the largest expenses for any business. When business
slows, you need to be positioned to reduce compensation quickly and
decisively. This isn't always fun, but it's a decision that a business
owner who knows the numbers must make.
Marketing
expenses. The
largest marketing expense is often advertising. You should be able to turn
up or slow down your sales by adjusting your advertising expenditures. If
there does not appear to be a correlation between advertising and sales,
then there may be something wrong with your advertising strategy. The
important point is that if you do not compare your advertising expenses
and sales, how will you know the effectiveness of your advertising?
Research
and development. R&D
effectiveness is not as easy to quantify as advertising. However, the
savvy manager sets a budget based on anticipated costs necessary to
achieve a certain goal. Be certain to periodically measure your progress
by comparing the amount spent with the proximity to the goal. Like
compensation and marketing, this is a variable number that must be
monitored and adjusted quickly to meet current needs.
Entrepreneurs
who know their numbers have a tremendous advantage over those who do not.
The financials tell a story--and understanding the story behind your numbers
can be one of the most important ingredients for long-term success.
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