Accounting 101 for Small Business Owners

July 18, 2012

Accounting 101 for small business owners

It’s rare to find a small business owner who properly understands the company’s monthly financial statements. Most owners concentrate on sales, expenses, and cash flow. Not withstanding the importance of these terms, the stories of companies with plenty of cash and profits are legendary. This is because most owners don’t concentrate on all of the many financial results and analyses that are critical to maintaining healthy financial performance and growth.

Consider the following:

A medium size flooring distributor was elated to see that its financial performance from 20x1 to 20x2 had improved. Sales had gone from $3 million to $4 million, and net income had gone from $300k to $400k. Gross profit percentage had increased a little also. Naturally, the company was not alarmed that its payroll had gone from $1.5 million to $2.3 million.

Using OnDemandAccountant.com’s tools for analyzing the many financial factors driving financial performance, we quickly found that the company’s productivity was in a serious decline. Our analysis showed that payroll should have only increased to $1.9 million in the second year, and that $400k of employee waste and lack of productivity was the main contributor to this decreased productivity. Net income should have been $800,000 in 20x2. Unfortunately, a recession took hold in 20x3, the company did not take our advice to trim its payroll and improve performance, and the company lost $200,000 on $3million in sales. Finally, the company took the necessary action, and as the recession eased,  slowly returned to profitability.

Traditional financial statements (balance sheet, P&L, cash flow) are lagging indicators of a company’s financial results. Without constantly analyzing the drivers of financial performance, companies are like a ship with a compass, but no rudder.

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