For many small businesses, December seems long ago. Christmas and New Year's are in the rear view mirror as we start down the long, cold road of the rest of winter hoping to see Spring sooner rather than later. In the meantime, while we wait for daffodils and other signs of Spring, we are also fast approaching that time when we prepare financial statements and pay taxes.
Since so much time and effort go into preparing financial statements and tax returns, they should be used for more than figuring out what amount goes to Uncle Sam. Many small business owners take this time to evaluate how their business has performed for the year, which typically translates into measuring and comparing profits, cash and other signs of progress and profitability. I would like to offer six suggested items for review.
This is typically the first item most small businesses look at to see how the year ended, and they instinctively compare it to last year's number and sometimes two or three prior years. Doing so may indicate a trend: growth, decline or even a mixed bag of growth and decline from one year to the next.
This basic trend analysis can be very effective especially in drawing attention to these changes and asking the important question of "why." Why are our sales increasing, decreasing (or both) over a two- or three-year period?
From that answer, can we identify, replicate and continue the reasons for growth? Alternatively, can we identify and correct the reasons for decline? Can we add new revenue lines and remove nonprofitable revenue lines to smooth out any volatility? Did we reach the sales goals we set last year? What are our revenue goals for the next year?
If a small business sells products, it has costs in acquiring those products. The business owner should monitor this cost of goods sold.
Year end is an appropriate time to pay attention to these costs as most businesses will complete a business cycle at least once in a 12-month period. Monitoring these costs of a 12-month period allows for the averaging out of purchases throughout the year.
Typically each industry has a benchmark ratio that compares cost of goods as a percentage of sales. This industry benchmark provides a starting point for comparing an individual business to the industry standard while giving it an indication of whether it is operating at a higher or lower cost compared to its competitors.
Also, comparing this percentage to previous years allows the business owner to see if costs are stable and to determine whether further analysis, such as looking at suppliers' costs and possibly diversifying supplier options, is necessary.
While most business owners will look at the profit made for the year as the bottom line, it is a good idea to see what expenses were incurred that impacted profit amounts. The business owner should compare each operating expense over time to look for trends.
It is especially important to compare changes in expenses both in dollar amounts and in percentages over the specified time frame.
By analyzing these changes in operating expenses and evaluating the reasons behind them, the business owner can decide whether to make adjustments to reduce costs. It is always a good idea to consider re-pricing services or products that the business owner purchases to support business operations.
Accounts receivable represent customers who owe the business money. Businesses that operate with accounts receivable should pay special attention to these accounts since their customers' creditworthiness drives the business's ability to recover cash from the sale.
It is critical to monitor these accounts, ensuring they are being collected in a timely manner, and not allowing any one account to grow to an amount that, should the accounts repayment begin to deteriorate, the business runs the risk of decline or failure.
Year-end inventory management may be a great way to reduce inventory taxes. Also considering the volume of inventory a business uses each year can be an indication of operations capacity and activity. Unused inventory is like wasted cash, so it is important to properly track and record all inventory.
Using borrowed money to acquire assets to generate sales or fund operations in anticipation of cash flow is normal for businesses. However, it is imperative for a business to scrutinize its operational cash flow so that borrowed money is used with maximum efficiency and manage debt levels to ensure that any debt used to purchase assets is being retired in a systematic way. The business owner should be able to explain and justify any debt-level changes to stakeholders in terms of improvement in sales, cash flow and value.
This is not meant to be an exhaustive list of items to monitor. Each industry has its own unique approach to determining appropriate levels of cash flow, profitability, debt, associated ratios and other indicators. Accurately-prepared financial statements are just the beginning of the review process, but evaluating these checkpoints and preparing these financial statements well will assist any business owner in making positive management decisions.
Chris Wooldridge is the district director of the Murray State University Small Business Development Center, which assists small businesses in many areas including business plan development, market research and financial analysis. For more information, call 270-809-2856.