Do you know the biggest financial mistake made by business owners? No, it’s not avoiding the CRA or failing to file taxes on time (although that’s a good way to raise a red flag with the CRA). It’s the very simple act of only looking at the bank balance.
Too often, business owners measure their business’s success by checking on their cash flow and assuming that money in the bank means that the business is making money. (Or, little money in the bank means the business is in trouble.) Why is this a mistake? Because money in the bank (or lack thereof) doesn’t necessarily mean your business is financially healthy (or unhealthy). There are a number of other factors that must be considered in order to determine how much money your business is making.
Understand where your money comes from
1) Know what’s driving revenues. The money in the bank came from somewhere. What products or services drove your revenues? And which ones were most profitable? Is one particular offering bringing in the bulk of your profits? Are some products or services not meeting your expectations? By understanding what’s most profitable, you’ll better understand the cash that is in the bank account and where it’s coming from.
Understanding your profitability doesn’t mean having to cut out products or services that bring in a lower profit, it simply helps you make smarter decisions. For example, are you selling a lot of one particular product or service and discovering that you’re actually only breaking even?
2) Review your fixed versus variable expenses. Every business has expenses. And those expenses must be paid. Whether it’s fixed costs, such as rent and phone bills, or variable costs, such as computer upgrades, the bills eventually must be paid from the cash in the bank. When these expenses come due, your cash flow might take a dive, but that doesn’t mean your business is any less profitable. What it may mean is that your expenses aren’t lining up with your receivables.
3) Manage receivables and work in progress. Setting up an accounts receivable (A/R) aging schedule allows you to manage outstanding invoices and continually gauge the financial health of your business. A typical aging report lists unpaid invoices by date ranges and provides insight into the paying habits of your customers. The same insights are needed when it comes to managing work in progress. Lengthy projects that aren’t billed until completion could cause large gaps in cash flow. Invoicing a percentage of the total at specific intervals helps level out your cash flow — which helps manage things like fixed expenses.
Cash may be king, but it clearly doesn’t tell your business’s entire financial story.
Now that you know how much money your business is making; do you have employees? And if you do, are you doing payroll properly? Our next blog lays it all out.