Being Busy Does Not Always Mean You Are Running A Profitable Shop
By Darryl Padgett
Implementing proper financial accounting will make that happen
What does it take to be successful? There should be a way to accomplish our goals and have fun while achieving them. Imagine this: what if you knew in advance a particular stock was going to double in price over the next year? Would you invest in it?
You would if you trusted the stock market and wanted to make money. What if you knew by studying your income statement that you could double your net profit over the next year just by addressing a specific problem in your company? You would certainly do this if you knew what the specific problems were, wouldn’t you?
It is likely we will never know what stock prices are going to do in the future. But, we do have the ability to monitor and anticipate our company’s financial condition. The key to knowing our problems is via the income statement. So many companies in this industry have gone out of business in the past couple of years that it has caused a ground swell of new business for other companies all across the country.
This is great news if you are the one surviving. However, just being busier doesn’t necessarily mean more profit for your company. By using this valuable tool, i.e., the income statement, you can have much better control of your financial future.
The income statement and balance sheet are tools that can give you insight on how to become more successful. Handling the financial issues for your company is a continuous task of managing change. The income statement gives you a moving picture of your company during a specific period of time. The balance sheet gives you a snap-shot of your company at a specific moment in time. Both are needed to evaluate the success of your company.
It has been said that a plane flying from New York to California is off course over 90% of the time because of the earth’s rotation and the weather. But they are continuously making adjustments to their course so they arrive exactly at their desired destination. The same is true for any business; it takes continuous adjustments to steer your company toward its highest profit potential.
Making a profit can and should be a planned effort. It doesn’t matter if your gross sales are increasing or if your sales are declining. It doesn’t matter if you are a one-man shop or a 50-employee corporation. What does matter is that you have a complete picture of your financial situation at all times. Your financial statements provide you the tools to do this. You need the tools in place; they need to be set up properly, and you need to monitor the numbers on a continuous basis.
The format of an income statement should not be taken for granted. You should plan how it is set up based on your company’s needs.
Don’t be afraid to change it if it does not meet your criteria. Many companies do not have the benefit of being able to produce their own financials in-house. They use low-end accounting packages and/or they rely on accounting services to produce them.
They may have also relied on their accounting services to choose how to set them up in the first place. Financial statements are often set up without determining the needed format for your specific business. Just a few of the most important aspects of what the income statement should have follow:
- Does your income statement show parts and labor sales separately? If it does not, you have little hope of evaluating your company’s true financial health.
- If you are on a merchandised purchased accounting system, the income statement should reveal if you have too much money invested in inventory.
- If you are on a cost of goods accounting system, then the inventory is a balance sheet item. (If you are on cost of goods, the income statement does not show purchases. Your actual cost is generated at the time of sale.)
- It should show what gross margin you are making on parts sales, and if it is enough to cover overhead in this department and make a profit.
- It should show what your direct labor cost is and the labor revenue generated by this investment. It should show what the gross margin is on labor sales, and if it is enough to cover overhead and make a profit. (Do you remember many years ago when shop owners had a machine shop not to make money, but just to bring in more part sales?)
- An income statement that is set up with your company departmentalized will provide you with even more invaluable information. You can view where your profits are being generated and where they are not.
An income statement that is departmentalized will reveal if shop supplies used in your business are excessive. Any part of the company that is out of line, cost versus revenue, can be identified so you can address the issue. Any expenses that are out of line or are getting out of line can be identified quickly.
Don’t be afraid of redesigning your income statement.
Another point that should be made is how often do you learn of mistakes your accounting service has made? Have they ever incorrectly allocated expenses? The bottom line will still be correct, but it skews the numbers in that you won’t know where to make adjustments within your company when needed.
And how long does it take your accounting service to get the financials to you? There are many companies that have to wait weeks or even months to receive them.
To receive them this late is simply ancient history as far as your business is concerned. If there was a serious problem, financially, this information is so late or after the fact that it is unlikely you will be able to manage a solution to the problem easily. The sooner you are able to respond to these types of situations the better. These are all issues that should not be taken for granted.
The financial statement that reveals if your efforts are adding to the overall benefit of your company is the balance sheet. It can show if you have enough net working capital to cover expenses. The more net working capital the better you can cover current liabilities.
If your debt-to-equity is too high, then the balance sheet will tell you this. It can be expressed in a ratio. The ratios that follow can show if you are at any risk of insolvency. If you are adding equity to your business, the balance sheet will show this.
There are financial ratios that we have all heard about but that few shops actually use. They are mathematical equations that let you know if your business decisions have been correct. The following are some of the formulas that reveal the financial heartbeat of your company. These financial ratios are not for your accounting service.
The first is liquidity analysis: It reveals the company’s ability to meet its financial obligations. It focuses on the current liabilities and the current assets. The excess of current assets over current liabilities is net working capital. The more working capital a company has, the better it has the ability to meet its financial obligations.
Typically you should have no more than one dollar of debt for every two dollars of assets. This helps to ensure a bank that what you owe will be paid. This is how it is computed: total current assets minus total current liabilities equals net working capital.
The second is the current ratio. The current ratio is a more dependable ratio as it pertains to liquidity rather than net working capital. This is how it is computed: total current assets divided by current liabilities equals the current ratio. Typically you want a ratio of 2.00 or more. It means that a company can lose half of its assets and still cover its liabilities.
The third is the quick ratio. The quick ratio excludes inventory from this calculation. Inventory is typically the toughest to dispose of. A quick ratio of 1.00 or greater is usually recommended. The quick ratio is computed as follows: total current assets minus current inventory divided by total current liabilities.
What is actually happening if you pursue these accounting efforts? You, the owner, are making a commitment to succeed. You need to know you are making the right decisions. Begin by getting your employees involved in the change. Ask them straight out if they are willing to assist in the transition.
It has been my experience that those companies that include their workers in the process of change and improvement succeed more often than those that don’t. Typically, by identifying for employees the issues, asking for their input, keeping them up to date with the progress, and setting a benchmark for them is what it takes.
By knowing precisely where your profits are being generated, you can implement the necessary changes within your company. This really is the fun part of change, i.e., to see the improvements and be able to share them with everyone involved. My hope is to encourage you to place an even higher value on financial management.
Each business is unique in its reporting requirements; there is no such thing as boilerplate accounting. One of the largest growing industries is business consulting.
There is a reason for this; you are in business to make a profit, but because of the many directions an owner is pulled, you simply cannot wear all the hats in a successful company. Any successful business owner will come to the conclusion that a simple accounting program cannot provide the quality of information needed.
If you are not there yet, there will be a day that you say, "Now I understand; I need a tool that will bring my company into the 21st century."
You must know what automation can do for your company, including the financial part. You must first recognize, or at least be curious about what you are missing. Remember, change is never easy. But the results of proper financial management will be even better than you can imagine.
I encourage you to beat out the competition and to be on the cutting edge of technology by pursuing the avenues that are discussed in this article.
Darryl Padgett, prior to joining the Pluss Corp., Columbia Falls, MT, was vice president of Midwest Crankshaft and Midwest Engine Parts Warehouse, Harvey, IL. He is a labor and management consultant for the Pluss Corp. His expertise lies in developing strategies for understanding sales and labor costs and in maximizing profitability in both of those areas of shop management. You may e-mail Darryl at: email@example.com.