Understanding Financial Statements: Managing Tips
This article concludes my series on financial statements and the importance of understanding the three types of statements. I used the analogy that financials are like aircraft instrumentation. For the business owner to ignore or not understand financials is similar to an airplane pilot ignoring or not understanding aircraft instrumentation.
It’s not a question of if, but when the business will crash.
I will wrap up this series on financials with some management tips that I received from Keith Cunningham, author of Keys to the Vault and financial mentor to Robert Kiyosaki (author of Rich Dad Poor Dad). The following items can be found on your balance sheet, with the transactions that affect them illustrated on your income statement, or cash statement.
Cash: Don’t run out!
Accounts Receivable: Collect from customers slowly enough to keep them happy and fast enough to keep you solvent.
Inventory: Three things not to get confused – what goes in (called additions to inventory), what goes out (called cost of goods sold), and what level to maintain (ending inventory position). Also, you can add to inventory in only three ways: make it, buy it, or burden it with manufacturing overhead. To buy and when to buy is always the question.
Other current assets: A favorite accounting concept is “working capital”, which is current assets minus current liabilities. The only cash in working capital is what is in the cash account at the top of the balance sheet. Don’t be fooled – you can’t spend working capital.
Fixed assets: Be sure you have enough operating cash flow, or can get enough cash from debt or selling stock, to cover investments in fixed assets and still cover your operating expenses. Sell or write off non-productive fixed assets – the ROA (Return on Assets) for a given net profit will go up if assets go down. ROA = Profit/Assets
Other assets: Be careful about investing in other companies – if you do, you’re assuming they will make a higher return on the cash than you can.
Taxes due: The taxes you accrue for this year whack your net income; the taxes you pay this year for last year’s obligations whack your cash.
Accounts payable: Watch payables turnover – pay too late and make vendors unhappy; pay too soon and run out of cash. Forget conventional wisdom that suggests stringing out your pay period. If you have plenty of cash, pay vendors promptly. You’ll keep good relationships and improve ROA by reducing total assets.
Debt: If your operating cash flow won’t cover operations and investments, you have to go outside for cash. Debt is one of two outside sources of cash, the other being equity. Creditors will lend money only if they are convinced that your future cash flow from operations can pay principal and interest.
Equity: If you have to go outside your company for cash, keep in mind you are selling future earnings or value. You want to sell enough to keep you from incurring debilitating financial risk, but not so much that you unnecessarily dilute your ownership…especially to pay yourself a salary.
Retained Earnings: Manage every item on the income statement to give you the net income you want. Manage dividends according to the kind of stockholders you want to attract. Dividends attract stockholders interested in income and shorter returns. Increasing retained earnings attracts stockholders interested in capital growth.
I encourage you to grow in your understanding of your aircraft dashboard instrumentation: balance sheet, income statement, and cash flow statement. Ask your accountant to explain each in more detail, or contact me. Become an expert in analyzing your business past and projecting “what if” scenarios forward. Your planning and ability to manage circumstances affecting your business will improve dramatically.
I am closing this series on financial statements with some quotes from Keith Cunningham:
“Too much money makes you stupid! Most problems are not due to a lack of resources, but due to lack of resourcefulness.”
“The quality of my decisions is directly proportional to the number of conflicting thoughts I can simultaneously entertain.”
When faced with an important decision, I suggest that you gather a small group of confidants. After you have performed your analysis and come to a conclusion, present your due diligence to your advisors and ask them to talk you out of your decision! Do you think that your decisions will be better as a result?
When making projections, remember; “What I don’t see are my assumptions”.
I wish all of you abundant success as you become experts at piloting your business forward to your desired destination – your dreams.
Always remember: “Fostering an attitude of gratitude is a key to happiness and joy in this life.”
– Rob Garibay –