During a meeting last week, a successful serial contractor who wants to change to complete investment mentioned that they returned to school at the age of 45 to obtain an MBA. Why, why, why? The response has thrown me off. While this entrepreneur had built multiple companies (with annual revenues exceeding $50 million), he felt inadequate as a potential investor. They specifically stated that they are unable to read company financial statements, such as a balance sheet, to determine the health and value of a company.
This caused me to pause and reflect. How many other entrepreneurs and small businesses truly understand how to assess a company’s health and financial worth by reading and applying financial statements or key financial measures? In my experience building a $2 billion company and managing four company turnover, I found the following financial metrics invaluable in understanding the health and potential value of a company. I also discovered that they are simple but effective “key performance indicators,” or KPIs. To run a successful business, let alone invest in one, every business owner must understand the financial metrics listed below.
While most people consider sales to be revenue, income, in my opinion, is money received in person. When you sell and don’t get paid right away, it may appear that everything is fine, but cash flow is king, and you’ll go out of business if you don’t have it.
Surprisingly, many small business owners are unaware of their high profit margins for their products and services. Here’s how it’s said: The difference between a company’s net selling revenues and its selling costs is its brutal margin (COGS). In other words, this is a company’s revenue that remains after the direct costs of producing the products it sells and the services it provides have been deducted. If at all possible, you want this figure to be higher than 50%.
This is not the money you think you made, but the money you made after all expenses and taxes were deducted. True profit. When reviewing a company’s expenses, make sure the owner does not combine personal and business expenses (e.g., car payments, house payments, etc.) to reduce net profit and tax liability. While the business owner/small business may benefit, the true profit of the company is distorted.
Cashflow is king:
A million dollars in monthly sales can be made and still go bankrupt. If you have to build the product and then sell it through a distribution channel, you will have to wait 60-90 days or longer to get paid for it. This may be an inaccessible business model in the long run unless you start with a large cash backlog or if you can afford the delay in actual income if your sales are high or your gross margin is so high (75 percent or higher). Cash is the fuel that keeps your company running; do everything you can to maximise cash flow.
Accounts receivable are funds owed to you by businesses.
It is one area where the company can fairly compensate its employees, but it is frequently overlooked. On Friday, a small business owner informed me that he had paid his payroll credit card. It was a $2.5 million company. You discovered that several of your customers owed you more than $400,000 and were past due by at least 60 days. We hired and paid a 10% commission on any bill we received in the next 30 days. We hired a billing service. Over the next 30 days, he collected $320,000 aggressively but not offensively.
I can best advise small businesses and entrepreneurs not to spend any money. At the very least, don’t spend money you don’t have. Avoid leases with no exit clauses and equipment that you don’t really need. Maintaining the company on purpose. If all entrepreneurs and small businesses are invited to attend a single seminar, it must be a negotiation seminar. Your ability to negotiate may have an impact on your company’s future potential.
This is an area that most people overlook and that more entrepreneurs and small business owners should focus on, unless you work in the human services industries. Assign a currency value to “billable or income hours” for your employees and, if possible, track their impact on income. You can only find out where you make the most income contributions and how much income per employee can be driven before you need to hire a new employee to avoid burnout.