60 What Business Owners Should Know About Financial Management

SPEAKER_04: This is the Empowering Healthy Business Podcast, and I'm your host, Cal Wilder. Each episode, we'll dive into topics important to folks who want to run businesses that are both nicely profitable, sustainable, and scalable, and who want to achieve balance in their lives and realize their potential inside and outside of work. The show is sponsored by SmartBooks, provider of bookkeeping and accounting for businesses. Let's get started.

SPEAKER_01: Sometimes it's make it or break it decisions that have to happen real time. For example, do you have enough cash to make payroll in a few months? Or do you need to take out a loan? Is one revenue stream tanking?

Are the margins shrinking? Are you pricing your product properly? Do you have the right staffing mix? So, like all of those things you don't want to wait to make changes as needed as you're running.

I mean the goal is always to minimize the bottleneck. So many tasks can be completed ahead of time, like you said. It's it's really trying to remove anything in that short period of time after month end when you're trying to close the books and bring it or complete it earlier in the month if possible. Um for example, like payroll can be posted every time a payroll is run.

So on payday, we can post a payroll, and that's not something that has to be done during during month end. Um also, you know, just posting the customer and vendor payments as they're made, um, keeping up with the bank and credit card registers and updating them weekly with new postings. Um I mentioned the uncategorized transactions. So if there's anything unknown, we try to resolve them within the week that we see them coming through the bank or the credit card to really minimize that back and forth during the short close process.

And that really can speed up the close process and resolve some of those bottlenecks ahead of time. SPEAKER_04: When we assess your current finances, we look at three main accounting financial statements. Uh, CPAs listening to this may point out there are actually four official financial statements, but uh, we're only going to worry about three of them. These are the income statement, also known as the PL, the balance sheet, and the cash flow statement.

And as business owners, we need to understand all three because the financial statements tell a story. It's our job to figure out what that story is. And so the only way to really do that is to borrow, and effectively borrow. This company effectively borrowed to help fund those distributions.

We look at our notes payable line, it went from 100,000 at the beginning to 150,000 at the end. So$50,000 of those distributions were effectively borrowed from note notes payable. Um cash has gotten a lot tighter. Cash is down almost in half from where it was at the beginning.

And if we start to look at some ratios, it gives us a little more color commentary on that. Our our cash balance is a multiple of monthly operating expenses, you know, was a pretty healthy 1.4 times at the beginning, meaning we had 1.4 times our monthly operating expenses as cash in the bank and never had to worry about making payroll or or uh getting on payment plans with vendors.

We can just afford to pay everything when due. Now, at the end of the period, we're down to 0.5x. And typically, when we get less than one, um it start to introduce a lot of stress and wasted energy and money to figure out how to pay bills and manage cash flow instead of doing things that are going to drive revenue and quality and customer satisfaction and retention and profit for the business.

And our approach is first to focus on the metrics, and then second, to set goals for each metric. And so the difference is, for example, if I've got a business with a cash flow problem and I think collecting from customers is the primary cause of my cash flow trouble, then um, you know, I need a metric around collections. And so on a weekly basis, my metric might be what's the percent of delinquent customers that we called this week? Or on a monthly basis, it might be what is the day's sales outstanding at the end of the month?

One of them is contribution margin. And so contribution margin is really gross profit minus the service cost of delivering those services or producing those products. And so it's a measure of value on one hand and cost efficiency on the other hand, right? Um if we've got a low contribution margin, it might be because our we're pricing our products too low, because either we're not appreciating how valuable they are in the marketplace, or we're competing in a commoditized marketplace where the customers will only pay so much and we just can't price high enough.

And so we're stuck with low margins because you know our product or service just isn't that valuable. Um and it's a reflection of cost efficiency. We could be charging a very high price for that product or service, um, and the market could perceive it to be worth the high price, but we might have a low contribution margin if we're very inefficient in how we deliver the product. As we more rigorously start to measure financial metrics, we usually find that we have trouble measuring some of those important metrics.

And this is because our accounting is not at a sufficient quality to produce the financial reports we need in order to accurately and consistently measure our metrics. Uh simply put, in order to manage the business using financial metrics, you usually need to upgrade your accounting operations to get the reports you need. So let's think of a pyramid, you know, wide base, narrow top, representing the primary kinds of work that go into the accounting function. We can refer to this as the finance stack.

At the base of the stack or the pyramid, there's bookkeeping. It's the most tactical part of the accounting and finance function, involving a lot of data entry and very basic accounting. Then above that, we have more hardcore real accounting, debits and credits and accounting management. Above that, we have financial planning and analysis.

And at the very top, we have C-level executive management, the CFO role, chief financial officer role, which is the most strategic part of the finance function. I'm going to present some of the key concepts from those two chapters here. So the first concept is a metrics framework. And by framework, I mean a system and a format and a common language that everybody in the company uses to track and communicate about metrics on a regular basis.

There are a number of different frameworks out there. Some of the ones you see more commonly are EOS or entrepreneurial operating system. It has a document called the Vision Traction Organizer or VTO, which includes, you know, it's kind of a one-to-two page business plan that has a 10-year target, a three-year picture, one-year goals, quarterly rocks, and then outside of that, there's a weekly scorecard to track weekly results. I don't believe running a business is a linear path with a defined start and a defined finish.

It's more of a loop, it's a cycle, right? Um you set strategy and goals, and you make some decisions that you think support those strategy and goals. You then operate the business based on those decisions. You periodically measure and report back on performance against those goals.

Um, you know, you're collecting data, you're listening, and you're observing, you're thinking, you're learning as you go. Um you come back to the manage part of you know, reassessing your strategy and goals, and you may tweak your strategy and goals and targets and you know, make slightly different decisions for the next period of time. And then you repeat that cycle of you know operating based on those decisions and goals, collecting data and reporting, and then managing to reassess strategy and goals and targets, and it's a cycle.

And so, in short, you kind of you manage, you operate, you report, and repeat in a loop. SPEAKER_02: And so now we take our profit first. You were told to take your profit first in business, right? Pay yourself first.

Now we actually do it and we control our spending, which you know, people are told you got to spend money to make money. I don't believe that's true. I believe there are better ways to do it. And it's just shifting our perspective on money and how we look at things.

I think it works in every model. I I've got a variety of different businesses in a variety of different places. What we find though is that you have to adapt the framework to the business. And so that I think is where the issues come up.

Their business is a little bit different. Maybe it's seasonal, maybe it's it's got um large bulk orders that need to be placed before the the season starts. There could be a lot of different parameters specific to that business. And the question is how do I model profit first and this the system to that particular business?

And then I think the second thing is start slow, go slow. Everyone wants to do everything full speed ahead. And when you do that, I think what happens is if you get failure in the first two or three months, people give up. SPEAKER_03: Yeah, so there's a couple of ways to get money out of your LLC.

Um, and I guess for our conversation purposes, I will say when I say LLC, I'm referring to um S-corps and uh partnerships. Um so the first one uh for specifically S-corps is W2 wages. Uh the second one is uh distributions, and then you can use um some discretionary expenses and infringe benefits to uh effectively uh pull money out of the businesses and treat them as as expenses. So uh, for example, like a home office expense, uh the business will reimburse you for the home office expenses, and it's a great way to get money out of the business, um, tax-free, um, and you get the the expense on the the PL.

It it would be very tempting, and uh sometimes it is a little too tempting for for some business owners. Um the IDRS doesn't is is on to us. They they agree that this is a legal way to to pay yourself and pull money out of the business, um, but you cannot treat yourself as an S-corp and pay yourself twelve thousand dollars a year as a you know CEO of a business. Um you have to pay yourself what the IRS loosely defines as a um uh a fair salary.

Now, they don't the tax code does not specifically define how to come up with a fair salary, what a fair salary is, there's no percentages. Um there are some industry standards that um that I've used, and there's there's kind of different levels on how to come up with that salary. SPEAKER_05: What is bankruptcy? And think of that not as a legal uh tool, but as a financial condition, and that's if you take the enterprise value of your company, you know, if you could sell it as an ongoing concern, and if you sold it, you couldn't pay off all your debts.

That's bankruptcy. That's when that's quote being bankrupt. Um and you may well be solvent and be able to pay your bills and keep going on uh until at some point something happens. Um, you can be not bankrupt but insolvent.

And insolvency is when you can't pay your current bills. So all of a sudden things, you know, if you can't pay your vendors, you can't pay payroll. Um, you know, the end is near, even if there's substantial value in the company. Um and that's what insolvency is.

And insolvency is often the condition that drives things in my world to start happening. Hopefully, you've made sure that you can uh make payroll and pay your final payroll. Um because that you know, there's typically personal liability for that. Uh you want to make sure you can always pay your payroll and any so-called fiduciary tax, which is the withholding portion of payroll taxes, uh, not the employ uh not you know, not the employer part.

Uh any sales tax that's been collected, conceivable any sales tax that's owed. Um that's generally considered fiduciary, and you want to make sure that you can you can pay that. SPEAKER_01: Yeah, so that's one of the things that we look at when we onboard a marketing agency is how it's set up to really tell the story and provide data that's going to be useful in decision making. So, I mean, we could set up a chart of accounts that's really simple, has one revenue line, one expense line, with the difference being the profit on the third line and at the bottom.

Um it would be very simple, but it wouldn't be helpful in giving us the information we need to make decisions. Um so we like to really look into the chart of accounts. Um, often we start by referencing the financial operating system, which is a book that Cal himself has written. Um, and we use that as a framework and a methodology when we're setting up the chart of accounts to really understand what it is that um the business owner wants to do with the business.

So um a lot of marketing agencies start out on cash basis, so that just means that um revenue is recognized when it's invoiced. Um, often if there's no invoicing, revenue is recognized when cash comes in the door and expenses are recognized when they're incurred. So there's no um putting things on the balance sheet, prepaids, um, accruals. Uh it's really very simple accounting.

Um, and that way the business owner can put their effort and their resources into launching their business. Um, it's an inexpensive way of doing accounting since it doesn't take a lot of effort to track things. Um, they can, you know, win new clients, do a great job of servicing those clients. Um, accounting isn't that critical in the early days of an agency, um, as long as they have a handle on the client media funds like we were just talking about.

Um and really the finer points of revenue and expense recognition might not matter as long as the business is um coming in and the firm is profitable overall um and there's cash in the bank. SPEAKER_00: Um so I I think uh this married couple doesn't always know they're married. Uh sometimes there are situations where you know the the functions themselves are connected, and you know, the the people in charge of these functions uh have sort of a dysfunctional relationship. Uh and I've seen plenty of businesses like that where finance is doing their own thing, operations is doing their own thing, um, and they're you know, sometimes looking at the uh the same data, sometimes the different data, uh, but there's really not a lot of collaboration.

And and there are there's so much opportunity there for making things work better for the business. Yeah, exactly. So in terms of solutions, what I what I found is is that uh finance and operations need to um uh co-design the business model uh basically. They need to work together on building on making a business model that that um helps them understand the business better and talk about things in the same language, uh, and also agree on on things like you know cycles, uh, you know, um uh terminology and you know how they want to see the data.

So building building those models together, I think, really uh makes the team work better. Cool. Um and and then on an ongoing basis, it's really reviewing the monthly reports. Um in some businesses I've worked at, um uh operations teams want to see data on a weekly basis because they you know they want to know that they're on track for for their goals.

Um uh but that data rolls up to monthly goals and quarterly goals. And so reviewing those together really uh helps each function understand the other function. SPEAKER_04: Another episode in the books. Thank you so much for tuning in.

For show notes and more, visit empoweringhealthy business.com. If you would like to have a one on one discussion with me, or possibly engage smart books to help with your business, you can reach me at cal C A L at Empowering Healthy Business dot com or message me on LinkedIn where I am easy to find. Until next time, this is Empowering Healthy Business, the podcast for business owners, signing off.