What do we mean by understand your numbers? Part 2

Mar 09, 2021 by Roger Scherping




In my previous blog LINK I gave many real life examples of small businesses and entrepreneurs making serious mistakes because they didn’t understand the numbers of their business. Here’s a quick summary:
 

  • Focusing only on the top line (sales) instead of on the bottom line (profit)
  • Not understanding how their sales break down across products
  • Not measuring gross margin and having no idea how much they make on each sale
  • Not understanding how their gross margin breaks down across products
  • Selling their products or services at a price that doesn’t cover their costs!
  • Inadequate control over the setting of prices
  • Not understanding the difference between markup and margin
  • Not understanding the difference between profit and cash flow
  • Entrepreneurs launching a startup without being sure they will make a profit

When I finished, I realized that I had missed some very important reasons why you need to understand your numbers, so I decided to write a second blog on why understanding your numbers is so important!


Do you need to talk to a banker about a loan?

A banker once told me a story about an entrepreneur who came to see him about a loan for a new business venture. The entrepreneur handed the banker a set of projections showing the anticipated sales and profits of the company over the first three years. As the banker read through the projections, he began to ask questions of the entrepreneur. But the entrepreneur just held up his hand and said, “Wait. Don’t ask me any questions. I had someone do the projections for me. I really don’t understand them.”

What do you think the banker did? He closed the projections and handed them back to the would-be borrower. There was no way he was going to loan any money to this entrepreneur. Here was someone who didn’t understand the projections he presented, someone who proved that he didn’t understand the numbers of his own business. Obviously he was not a good prospect for a loan.  The entrepreneur did not impress the banker.

To borrow money, you need to demonstrate that you have a great product or service and a thorough business plan. You also need projections that prove that financially you have a solid business model.  You have to understand those projections thoroughly and be prepared to answer questions about how they were prepared and the assumptions that underlie them. The very best way to do that is to do the projections yourself!

Find a tool that will help you do that. We created ProjectionSmart Startup to walk you through the process of preparing your own projections, even if you don’t have a background in finance or accounting. Startup will take you from the theoretical, high level vision and help you think through all the details of your vision. You’ll list your products or services, prices, costs, and financing plans. We’ll walk you through it slowly and carefully.

When you’re done you’ll have a complete set of projected financial statements. You’ll view the results and then go back and make changes until the results match your vision and you can really believe in the results. You’ll be ready to meet with that banker and able to confidently explain what the projections mean and why you believe you can achieve them. You will inspire confidence with your banker!


Understand the financial impact of your business decisions

I once knew an entrepreneur who bought a franchise for three stores. I was there when he opened the first one. As we walked through the store, I asked him, “How will you know when it’s the right time to open the next one?” He turned and looked at me, shrugged his shoulders, and said, “I have no idea.”

Like most small business owners who don’t have a background in finance or accounting, he had no method to answer this question. He simply didn’t understand the numbers of his business.

One of the smartest things a small business owner can do is learn how to understand the financial impact of their business decisions. Is this the right time to open the next store? Can I afford to buy that new piece of equipment or hire that new employee? What would the financial impact be if I launched that new product line?

Instead of just making decisions on gut instinct, run the numbers! Model the decision and compare the expected results to your current baseline. How do profits change? How does cash flow change? Will you require a bank loan to make it happen? What impact does it have on your balance sheet?

Find a tool to help you model your important business decisions. We created ProjectionSmart Growth to help you do just that, even if you don’t have a background in finance or accounting. Growth will carefully walk you through an analysis of your business decision, and you’ll have a model of the financial impact of your big decision.

When you’re done you’ll have a complete set of projected financial statements. You’ll view the results and then decide on what changes you need to make your idea a reality. You’ll have the confidence that comes from KNOWING what’s going to happen, instead of just winging a critical business decision.


Walking close to the edge

Let’s face it, a lot of businesses didn’t do well in 2020, and they might find themselves walking on the edge of disaster here in 2021. I know from having turned around a number of businesses that the first thing you need to do is figure out what your financial future looks like! You need the best possible picture of what’s ahead so that you can create a plan that will get you back on solid ground.

Find the right tool to help you. In less than an hour ProjectionSmart Growth will help you create a business projection that will show you what your business looks like 12 months out. How does your cash look? Do you run out? How about profit will you make? Can you recover from the effects of 2020?

Once you have a good idea of what your financial future currently looks like, then you can create a success plan. There are lots of things you can do to turn things around. Do you need to recover lost sales? Do you need to get your gross margin back up? Is it critical that you reduce your overhead to keep cash flow positive? Model each decision to see the impact it has on your profits and cash. When you have a model that gets you where you want to be, then you can create a plan to make that vision a reality.

One thing I’ve learned is that the sooner you take action the better! It’s much easier to make changes now than to wait a few months. By then, things will be much more desperate. Your model will tell you what changes you need to make to your business, and then act immediately!


Doing OK in 2021?

Maybe you were one of those businesses that weathered 2020 and came out no worse. That’s great, but you can still improve. Do you know what levers you can pull to improve your business results?

Try running some what-if scenarios. What if your sales went up 5%? How would that impact profit? What if you increased gross margin by 1%? Or reduced inventory by 5 days cost of sales? Or collected your receivables 5 days faster? What would that do to your cash flow?

ProjectionSmart Growth will help you easily model these different scenarios. Then you’ll know what actions to take to get your business to the next level.

The side benefit of doing an analysis like this is that you will learn so much about your business. You’ll learn what drives your cash flow. You’ll see where the greatest opportunity is to raise profits. You’ll know how gross margin impacts your profitability. Understanding your numbers will improve your management ability!


Then what happens?

Once you understand your numbers, you will experience the peace of mind that comes from being on top of your business: understanding what drives your financial results, confidence in your business decisions, and knowing what the future holds for your business.

Someone asked me once, “What do businesses do if they need a projection for a banker? How do they do a projection if they don’t find a tool like ProjectionSmart to help them understand their numbers?”

In my experience, they typically don’t do a projection. Small business owners have told me that when their banker requests a projection, the owner asks his CPA for help. The CPA says, “Yes, I can do that. But it will cost about $3,000.” The small business owner thinks that’s too much, so they decline, and they tell their banker that they need help. So the banker gives them a spreadsheet to fill out, a spreadsheet that he uses with all of his clients. The small business owner spends enough time on it to satisfy the banker, but the small business owner gets no smarter about their business.

It doesn’t have to be that way. You can understand the numbers of your business. You don’t need a background in finance or accounting. Let ProjectionSmart help. We have tools created just for you. I guarantee that you’ll find it’s much easier than you think!

Roger

 

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