Why Small Business Owners Must Understand Financial StatementsJuly 9, 2017
As a small business coach, many times I will start the initial conversation with a new client by asking the business owner: What are the financial statements? I have gotten such perplexing answers as: A bunch of numbers on a piece of paper? A tax return? A bank statement? Does it have to do with a balance sheet? Are there revenues involved or is that even on a balance sheet? Does it involve revenues or gross profits?
From years of working with small business owners, it is very apparent that most small business owners don’t utilize their financial statements to manage their business. As a result, they usually can’t read or understand their financial statements. My business partner, Jack Mencini and I have seen grown, husky men cry when we ask them to tell us what they see on their financial statements and tell us what the numbers mean. Unfortunately, the great majority of these business owners give us that look like the deer in headlights because they have no clue how to present what is detailed on their business’s financial statements. No one’s ever taken the time to teach them. Most small business CPAs are missing out on the opportunity to teach their clients the numbers by having their clients present the numbers.
Many small practice CPAs feel that they usually do a good job explaining the aspects of the financial statements when they present the client’s tax returns or quarterly financial statements. As a business coach and having tenure in the financial profession, I know that most small business owners don’t know how to read the financial statements. The short summary from their CPA at tax time really doesn’t give them all the knowledge they need for understanding and planning for their business throughout the year. Most business owners know they should know these numbers, and after being in business for several years, most people assume the business owner knows the numbers. Many are too embarrassed to admit they don’t understand their numbers, which is why we have all of our new clients present their financials to us during our first meeting. You can’t fake your way through a presentation.
With solid understanding of the financial statements, a small business owner will know, and more importantly, understand on how to take action. Knowing what the numbers represent and what they are telling you, allows you, as a business owner, to succeed on purpose. We tell our business coaching clients that our definition of business success means to achieve growing and sustainable profits. Without sustained profits, you’ll eventually run out of cash and be out of business.
As a business coach for over 15 years, I am often initially seen as a nuisance to my client’s CPA or financial advisor. This is due to the fact that the small business owner will have to get answers to many questions they don’t have answers to. In turn, the small business owner will turn to their CPA or financial person and that individual says: “Well, why do you want to know that?” The answer to give the CPA is that you are working with a coach who says I should know the answers. It’s key to break down the poor communication that often exists between CPAs and business owners. Typically the CPA thinks communication is great, but the owner is typically frustrated. Believe me, it’s rare that a client of ours raves about their CPA.
Why You Need to Understand Financial Statements
A big reason why understanding the financials is so important is that it allows you, as the owner, to do one of the most important things for your business, which is to create a profit plan for your business. You may have heard it called a budget, but budgets often miss a key component, which is the sales forecast and not just expenses. The profit plan is impossible to pull together if you don’t understand financial statements.
So the first step for you, as a business owner, is to figure out what all the numbers on your profit and loss and balance sheet mean. Once you understand them, the process of projecting out those numbers for the next year isn’t so daunting. In fact, it becomes tremendously empowering. Picture having a road map for the next year for how your business is going to make money over the next 12 months. That is usually hard to imagine for most business owners.
Most owners have an idea of how much money they’d like to make this year, but a recent discussion I had with a business owners shows how a gap often exists between what the owner would like and how to get there. I asked him what his goal was for the year. His response was, “My goal is to have a $100K in profit, because I did that last year, but when I went to the bank, the money wasn’t there. For this year, I would like to end the year and see $100K in my bank account.”
After a few more questions, I helped him understand where all the money went in the prior year. Paying down debts. Stocking up inventory. Paying taxes. Late paying clients, which resulted in Accounts Receivables piling up. So for him to be able to have $100K left in the bank at the end of next year, he would likely need to have profit of about $250,000. I wish you could have seen the smile on his face. He had been wrestling with this question for a while and now he finally had an answer!
If you put a good plan together, it is surprising and exciting to achieve the plan and be focused. By understanding the financial statements, as a small business owner, you will begin to take management action to make things happen.
Running a company successfully is not nearly as hard as some people make it out to be. Understanding your numbers is a key first step to simplifying that process.
You don’t need to become an accountant or CPA to read a financial statement, but you need to know and keep tabs on the numbers to run your company and achieve your profit plan.
Those small business owners who have reached out to coaches to help them understand financial statements take on a new demeanor that is a mix of being calm and excited. It boils down to the confidence they have in their plan and running their business. At the point of knowing that they fully understand their business, the realization surfaces that they can steer their business in the direction for sustainability, success and profits. That is powerful!