Are you failing to plan?

You may be planning to fail

We are hopeful your store gets a pair of monthly financial statements; a profit and loss statement, also known as an income statement, and a balance sheet.

The first document tells you what happened in your store, most frequently the past 30 days or the past 12 months. The second document shows how much of the business belongs to you. You may be thinking the whole business belongs to you but if you have any outstanding bills, what belongs to you is what is left after all the liabilities are paid.

Let’s look at the balance sheet to get some perspective about our planning. The top half of the balance sheet is titled, “assets”. Within assets they are subdivided into “current” and “fixed” or “long term”.

The current assets, by accounting definition, are those assets that are expected to be converted to cash within the next 365 days. The fixed or long-term assets are those expected to remain in their same form.

Looking at the assets we will first look for what is the biggest dollar amount. With most businesses the biggest dollar amount will be either the building or the inventory depending on whether you own the building.

The only way you can make money on the investment in the building is by selling it, or by mortgaging the building and using the money to profitably sell and turn more inventory.

If you are leasing the location for your business, then inventory is surely where the bulk of your assets lie.

Your other assets will include the money in your checking account, fixtures, equipment, and point of sale system. While all of them are assets, they only have value when they are helping you and your business make more money.

Before we look at other components, we should look at the liabilities section of the balance sheet. This section represents the money your business owes to individuals and companies. Within liabilities, this section is also divided into two parts. With names that are similar to those for the assets, they are the current liabilities and long-term liabilities. The explanation for liabilities is much like assets. Current liabilities are those to be paid within the next 365 days and long-term liabilities are those to be paid in a time frame longer than 365 days.

There is a third part to the balance sheet which is of utmost importance to you as it represents your ownership position in the business. It is called equity, net worth, stockholder’s equity, or something similar.

Before you begin to make any plans for the future, there may be several components of the balance sheet that are important. We want to look at one factor that speaks to the expected health of your business for the next 365 days.

It is a financial ratio you may have heard your accountant mention. It is the “current ratio” and much like the name indicates, it compares the current assets to the current liabilities. If you remember from your math in school, you divide the assets (the numerator) by the liabilities (the denominator).

With the current ratio you are comparing what you expect to be cash in the next year against what you expect to have to pay in the next year. If the current liabilities are higher than the current assets, you are going to have to borrow some money or make some big changes in the business to be able to pay the bills.

If your answer is close to 1. or lower, there is reason for concern because your business is expecting more bills to pay than you expect to have cash on hand. With an answer that is higher, the stronger the immediate future of your business looks. This means the more the current assets are larger than the current liabilities, the better the chances you will be able to pay your bills.

Before we look at a budget, you will want to know about the stability and viability of your store. Current ratio will tell you if there is a problem to be solved and there are restrictions of how you spend your money; or if it is OK for you move ahead with plans of growth for your store.

If the current ratio is too low, the initial solutions we would offer is that of your injecting cash into the business. That improves the assets and by putting cash in you have improved your equity position. Loaning your money to the store will mean you need the debt to be shown as a long-term liability instead of a current liability.

You can also look at rearranging the existing debt. Being able to move some of that current debt into long term debt will help to improve the current ratio. If you have a loan with a bank, this is a good place to start.

The next step is your beginning to create a budget for your store. We will first consider an existing store where you should have several years of track history. Gather the monthly profit and loss statement for the past three years and begin to look at each line of information. Start with your sales; what is the change in January sales for each year. Is there a pattern of change you can detect?

You do the same exercise for your margin and each of your expenses. Visiting the Profits Plus website, you will find an Excel based calculator that will allow you to build the comparison for the three years in a side by side analysis. And if you are doing this exercise in mid-year, we have added a fourth column that will allow you to put your year to date numbers for this year to see if the trends are continuing.

Seeing that pattern of change will allow you to make a very educated guess as to what the next January will be like. Doing so, you will be creating a futuristic January profit and loss statement. We call it a budget.

Do this for each of the twelve months and you will have an annual budget. As you can see, it is your experience that is the most important factor. You now know why you should not allow an accountant or some piece of software to create your budget. Your experience and your knowledge are the key components of creating a budget!

There are also several other factors that need to be considered. Frequently in independent retail, the person owning the store has made the decision to be a retailer more from the passion of loving the products and not from loving to be a profitable retailer.

What do we see happening? We see people who own a building and decide to put a store in the building. As they own the building, the store they also own does not pay rent. If this business is showing a profit, it is a false profit and the expenses are unrealistic. While the owner of both building and business are the same, they should be treated as two separate entities.

There is often a similar situation with payroll. The owner of the business is working in the store, but as they write payroll the paycheck to the owner goes in a drawer and is uncashed because there is not sufficient cashflow to pay the owner a reasonable salary. The budget may look correct but the reality is this is not working.

Another situation is the owner who does not draw a paycheck from the business, yet they are working full time in the business. Frequently with this situation we see payroll, as a percentage of sales, is within acceptable limits, but the reality is that someone is working for free.

A final observation is the owner of the store who is not actively working in the store, not drawing any income from the sizable investment they have in the business and worse yet, using some of their pay from another job to pay the operating expenses of the business. This situation is wrong on multiple counts.

The first situation is to look at the amount of money the owner has in the business. If that money were invested elsewhere, there would be an expectation of receiving a return on investment. Why isn’t there a return on investment in the store? This sure makes for an expensive hobby.

If not working in the business, the money in the business should be producing a return to the owner. If the owner is working another job and using that pay to prop up the store, the only way this works is if the owner has created a budget that is able to forecast a date in which this stops happening.

With the situation of the building, or any of payroll scenarios we have just outlined, there has to be a planned timetable for changing this. Hoping that someday sales will increase enough to address it is not enough. Hope is not a strategy!

Addressing that point, we have created and put another calculator on the Profits Plus website which will show you how to calculate the return on investment. However, it is only good if situations like the building and payroll are as they should be.

The follow up step to the budget you have created is with each month as you receive the profit and loss statement from your accounting system or accountant, you compare the statement to your budget. Looking at your plan and the actual side by side numbers should help you in making each of the next eleven months of budget to become more accurate.

You then create a new budget for that month in the following year so that you have a continual twelve month projection for your store. This budget is a must have tool so you can see if your business is operating according to plan – your plan.

All of this needs to be done before you begin to look at that big asset – inventory. Thinking that inventory should be looked at first is like rearranging the chairs on the deck of the Titanic thinking it is going to make a difference. It will not! You have to know if the business has worked properly in the past and make your plans for the future.

And now you come to inventory. Now you can begin to look at what this inventory is doing for you and can do for you. Today we will look at how much inventory you will need from the perspective of the space your business occupies. Hence we are looking at what could be your two largest investments. We begin with the size of the store; not just the sales area but the entire store. This is because your rent or mortgage is for the entire building.

The next step is to look at the sales you want per square foot. This is a bit different method, but when multiplied by the total square footage you get an amount which is your total sales. This should agree with the sales you planned in your budget. There is a calculator on the Profits Plus website that will determine that number for you.

When you have used the Return on Investment calculator you received as one of the answers the number of inventory turns per year. This is where you insert this number along with what you anticipate will be your maintained gross margin. Maintained gross margin takes into consideration any markdowns. The resulting answer is how much inventory you should have on hand at retail. (A number you will easily obtain as you take your annual physical inventory of the store) and the inventory you need at cost.

These three calculators are provided to help you create your plan for success. Because by failing to plan, you are likely planning to fail!

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