This post originally appeared on Signpost’s business blog. It has since been modified from its original form to fit the indinero blog, Our Two Cents. Enjoy & thank you for reading!
Pop quiz! Do you know if your business is on track to hit its financial goals for the year?
Sorry to put you on the spot like that and don’t let it make you sweat. Truth be told, an estimated 90 percent of small businesses are unable to produce dependable financial statements when prompted. And it’s probably safe to assume that even if they could access accurate finances, most small teams wouldn’t know how to turn those numbers into business insights to put into action.
We usually think of entrepreneurs and business owners as the most confident folks in the room. So, it’s worth noting when something makes them squirm the way accounting and taxes do. Even though we all know that hiding from scary financial issues does nothing to actually make them go away, so many fearless business leaders are quick to bury their heads in the sand before addressing topics like month ends and EBITDA margins.
However, this can be a major differentiator when it comes to running a successful company. Taking a deeper look at some of the most of the notable businessmen and women we see in the spotlight, you’ll see that they got where they are today by facing the intimidating financial world and becoming one with their numbers. With that in mind, you’re probably wondering what exactly they did to get under the proverbial accounting hood? What were their first steps?
Suggested Reading: Top 7 Accounting Terms & Equations for Running a Business
Let’s start by looking at the reports you’ll need to make the right managerial decisions for your business’s goals. Once you have that as a foundation, we’ll dive into which financial reports matter to each audience of interest (such as investors, creditors and lenders, and tax authorities) and how to make the right impression from the beginning.
Accounting must-haves for making high-stakes decisions
Let me level with you: The data you need to make impactful business decisions isn’t going to just fall into your lap. Most founders don’t always have a degree in business or finance. So, depending on your goals and the tools you have access to, getting the right performance metrics can get complex.
Chances are you’re already asking the right questions:
How can I truly judge our financial position?
Which ratios indicate what?
Is there a perfect way to answer investor questions?
Could I be optimizing my team’s operations?
These are natural questions for an efficiency-oriented executive to ponder, but finding the answers is not as simple as looking at your bank accounts, glancing at the money in there, and calling it a day. Luckily, good accounting can give you those answers and help you identify these areas as well as where you are over-performing, underperforming, or right on track.
Once you have an overall ledger and chart of accounts to use to compile your financial statements, you’ll uncover answers you need to make key leadership decisions within three primary accounting reports: Your profit and loss (aka P&L) statement, statement of cash flows, and balance sheet. These reports are pulled at the end of each month after all transactions have been reconciled and your books have been closed.
Here are a few areas to focus on when you dive into these reports and interpret your business’s finances:
- Categories of spending such as technology/equipment, promotional, utility, or departmental costs and earnings from avenues like new sales, subscriptions, returning customers, or partnership paybacks
- Monthly spending and recurring expenses within your budget
- Different streams of revenue, expenses, and analyzing different trends that happen over time.
Use Financial Reports to Inform and Educate External Parties
Whether you are looking for growth capital or just doing your best to avoid compliance issues, outside parties like creditors/lenders, investors, and tax authorities use your business’s financial reports in different ways:
How to use financial reports to secure a business loan:
Creditors and lenders use your financials to evaluate risk by assessing the liquidity of your business. They will need to access the business’s balance sheet to analyze cash flow and get an overall measurement of assets in comparison to the overall liabilities (what you own vs. what you owe). This is called analyzing your Current Ratio (Current Assets/Current Liabilities).
Ultimately, the higher the Current Ratio is, the more liquid you are as a business and the more likely you are to be able to meet and pay off your short-term liabilities and obligations (aka make your loan payments). Depending on your industry, a good Current Ratio to aim for is at least two to one. However, due to the limited number of liabilities associated with running a tech/internet based company, they are expected to have a higher Current Ratio than say a manufacturing company. And, if you’re a company that holds inventory, they’ll want to look at the Quick Ratio which also uses current assets but instead subtracts the actual inventory you have before factoring in your current liabilities.
The financial statements you’ll need during an investment round:
When meeting with investors, it’s obviously important they are on board with your product or idea, but if they can see you’re also passionate about getting into the financial details, it will really set you apart as an investment opportunity they won’t want to miss out on. Your propensity to drive an ROI-focused business will be put to the test as they dig into different financial ratios, here are a couple figures worth focusing on and what they’ll tell investors about your business:
Investors will want to compare your long term liabilities to the business’s equity. You should be able to access and present this information from both columns in your balance sheet. From here you can also show investors how wise you are at allocating your resources and spending with a plan for return. Use your balance sheet once again to determine your Return on Assets (the higher the better here):
Return on Assets = Net Income/Average Total Assets
Now, determining a desired outcome for your Return on Assets can be tricky and somewhat arbitrary for early stage startups. Basically, if you’re a growing tech company this number may seem low. Don’t be discouraged, just be aware that questions may arise and use that knowledge to prepare to justify your spending.
Really, investors and venture capitalists will want to have as much financial knowledge about your company as possible when evaluating the opportunity. After all, they are most interested in their profitability, how they can diminish their risks, and determining the ultimate return of the business as an investment.
Plan for tax season using the right financial figures:
If your business is based in the United States, you’re responsible for filing a tax return each year and paying any liability you may owe on your taxable income (on time). As a profitable business, you will also be responsible for making estimated quarterly tax payments throughout the year.
Tax authorities (like the IRS) use your financial statements, specifically your P&L, to see your income and expenses. You will use this report to determine your net income and tax liability and plan accordingly for tax season (preferably more than a few days before your return is due!). This is what you’ll owe and pay as a profitable business when you submit your tax return.
Where’s the data? How businesses generate their financial reports
Now that you have a better idea of how to put your finances to good use, you’ll want to start reviewing these reports at the end of every month so you can assess your company’s performance. But like I said, these figures don’t just appear out of thin air, nor are they easy to extrapolate from a bank statement. You need to have a dependable accounting solution to pull accurate figures from.
Luckily, there’s never been so many options on the market for managing your back office (what a time to be alive!), but deciding on the right accounting provider for your business is a considered choice. At the very best, choosing the wrong accounting or tax provider can create unnecessary barriers to growth that cost you time and money… while the worst choice can riddle your business with painful financial inconsistencies and a backlog of compliance nightmares. We recommend doing the research to find the solution that makes sense for your business’s budget and company size as well as your goals for growth and any specific compliance requirements you might have due to the nature of your business or industry.
Or, you could consult this guidebook of well-researched vendor comparison charts, scopes of different accounting and tax services, and interactive exercises to help find the right solution for you. That’s right—we did all the work, you get all the benefits!
