Many business owners don’t accurately know what’s going on financially on a month-to-month basis. Yes, we can all see if the bank account is going up or down. The good news is that’s the first indicator of cash flow reserves and monthly profits. The problem is that it’s not enough data to do anything about maximizing profits or minimizing expenses. What is the best way to keep track of your business finances?
Peter Drucker – author of many executive leadership and business management books, is quoted as saying “If you can’t measure it, you can’t improve it”.
The best way to start this topic of tracking business finances is to start simple and get more complex. I’m a fan of keeping things easy to understand and implement with maximum value.
If you’re just starting up your business, be sure to keep your business and personal finances separate. It’s not only a great habit, it will keep you protected once you form your official business entity. Co-mingling of funds is something a lawyer can use against you if your business is sued to pursue your personal assets. In the eyes of the law, mixing personal and business funds is telling the world that your business is actually a “hobby”.
The simplest way to start is to get a separate business account and then code all your income and expense receipts and separate them in folders. You can keep track of the numbers on paper, but I’d highly recommend using a spreadsheet that automatically totals up your income and expenses (your Income Statement). You can also keep track of your assets and liabilities this way and create your Balance Sheet and calculate your business’ net worth.
If you’re rolling your eyes and thinking that this is too simple, please hang in there. I will provide valuable information for even you experienced, financially savvy left-brained entrepreneurs as well.
Once your business has proof of concept (meaning money is promised or coming in), it’s time to set up your financial software. The most common business bookkeeping software I know of in the United States is QuickBooks. The software is affordable and has great capabilities and is relatively easy to learn. It can even keep track of your customers. Most cities have certified QuickBooks instructors, just do a quick Google search. If you plan on doing your own bookkeeping (which I highly recommend against), at least hire a bookkeeper to set up your chart of accounts. Your chart of accounts is essentially how you “bucket” or separate out your sources of income and types of expenses. Examples of expense items might be marketing, office supplies, payroll, etc. Then have your accountant review your chart of accounts to make sure you are maximizing your business tax writeoffs and not missing anything.
As a side note, I highly recommend meeting with your accountant at least twice a year. There should be no surprises for you at tax time. The second meeting is for strategizing and making changes while you can in order to minimize your tax burden. I believe in paying taxes, and as small business owners, we work very hard for our money and deserve to use the IRS tax code wisely.
Now you have a system for entering in all your financial data and keeping track of your monthly income statement and balance sheet. Your bookkeeper can run automated reports for you monthly and I highly recommend looking at all the details once a month to see where you can do more of what’s working and fix things that aren’t. If you have products or retail operations, looking at your inventory and seeing what your best and worst sellers is a great idea.
In addition to looking at your major reports monthly, it’s also very revealing to look at your reports from last year to this year. Are you more or less profitable? Why? What can you do to improve?
Here’s the tip that most of you have been waiting for. This is a financial tracking practice that every business owner should employ immediately!
Go over your expenses with your bookkeeper and identify your fixed and variable costs. Fixed costs are expenses that you pay every month no matter if you do business or not (they may vary month to month – like utilities). Examples include rent, insurance, utilities, internet, marketing, etc. Variable costs go up the more products or services you sell. Examples include payroll, shipping, packaging, COGS (Cost of Goods Sold), etc.
The next step is to have your bookkeeper create a custom report for you. The report should show 4 items on a monthly basis: total income, fixed costs, variable costs and profit. This report is easy to understand and interpret and extremely valuable for troubleshooting and maximizing your business opportunities. Take a look at the report and highlight peaks or valleys. You should be able to look at your detailed reports and quickly see why these fluctuations or outlying points are there. If not, it is time for forensic analysis to see what’s going on.
For example, if you see a huge spike in fixed expenses, maybe it’s a super cold winter and utility costs went up. Perhaps you are paying your vehicle insurance twice a year and the spike is due to a bulk payment rather than a stable monthly one. This also allows you to plan ahead and budget from an annual basis for what used to be “surprise” expenses. Do you have seasonal fluctuations in income? What can you do to increase income in the off season?
Now you have a simple yet elegant and valuable method to track your business finances.
Please comment below with your experiences and ideas. How did this help your business? What other suggestions do you have for tracking, measuring and improving business finances?