Know your financials

There is a lot of profit in the financial statements

Talk about a waste of money. Most retailers will spend more than $100 every month to get several pieces of paper and a few minutes from an accountant. The waste occurs because after meeting with the accountant, the retailer knows as much about their financial status and what decisions to make for their business as they did before they met with the accountant.

While this is the experience of most retailers, this is not the way it should be; the accountant should be providing more information and in a format that makes decisions much easier for the retailer. Of course, your challenge is to know what to ask.
 
The two items you need are a monthly balance sheet and a profit and loss statement delivered in a timely basis. (Three or more weeks after the end of the month is not a timely delivery.)

The profit and loss statement should be arranged in a manner so that it is a useful tool for you. Our suggestion is that the document have each of the line items stated in a dollar amount and as a percentage of gross sales.

Your operating expenses should be arranged into four groups. The first group is for your advertising, marketing, donations, and related expenses. The second group would be your occupancy costs and would include items such as rent or mortgage, property taxes, utilities and related insurances.

The third group is your payroll expenses. It would include all of the pay, workman’s compensation, benefits, and other expenses related to employees. The final group would contain anything not listed in the first three groups.

The logic for this suggested arrangement is to create a document you can quickly read, understand and use to make decisions.  The groupings are suggested because the first three are the areas of operating expenses that you have the most control over. As an example, most retailers would be concerned if their occupancy costs were more than 10% or their payroll exceeded 18%. When a grouping exceeds the suggested ceiling, you would then look inside the grouping at the individual expenses in an effort to determine which should be decreased.

As you look at your profit and loss statement for the month, the logical comparisons you would want to make would be to the same month of last year as well as comparing last year and this year to date. While you are adding information to your statement, columns for your monthly budget and year to date budget can tell you what you have accomplished as compared to what you planned.
Instead of your looking for all of this information in your file cabinet, you could have your accountant have all this information on the one profit and loss statement. It is simply a matter of your accountant arranging the information in the format that you can easily understand and utilize. Having eliminated the time needed to locate the historical documents for your store, you will find yourself spending a short amount of time to make the comparisons and decide the things you need to stop doing, the things you need to do more of, and the things you should tweak.

Now you have a document that is a tool that will help you operate a more profitable store. Profit does not come from working harder or working more hours; profit comes from doing a better job of being the owner of a business.

Of course, profit does not mean you always have adequate cash on hand. The article in the next issue will show how to accurately anticipate your cash needs as well as how to create a plan for having that necessary cash.

The second item, a balance sheet, is one that traditionally does not get a lot of attention from the retailer. However, as many retailers see the eventual sale of their business as being their ‘retirement plan’, the balance sheet tells you if you are making progress toward that goal.
A second, and very important, concern for your balance sheet comes into play if your business has a loan with a bank, finance company, or individual. In the many pages of the loan document there are components which are referred to as ‘loan covenants’. In the loan documents you signed, the covenants state the loan is valid only if certain parameters of operating the business are maintained.

In making the determination, the lender is going to expect to receive a copy of the profit and loss statement and the balance sheet on a schedule specified in the loan. Perhaps you have heard your accountant or the lender mention phrases such as ‘current ratio’ and ‘debt to equity ratio’. Reference to these, and other financial terms are contained in the loan covenants.

If your financial statement information gets outside the stated parameters there are several things the lender may do. They may increase the interest rate you are paying; they may shorten the term of the loan; they may call the loan to be paid in full immediately.
In performing the math, the lender uses information from your financial statements; statements which may or may not be properly stated. Having the information properly stated requires your understanding some accounting terms as well as your being able to have a conversation with your accountant in which you can ask and answer questions relating to the data on your balance sheet.

Most retailers would know that the assets on your balance sheet represent the dollar value of items that your business owns. You would also know that liabilities represent the dollars the business owes to various lenders and vendors. Within both the assets and liabilities, each are broken into two categories – current and long term. As a side note, some accountants use the word ‘fixed’ instead of ‘long term’ when referring to the assets.

Current assets are those items belonging to the business that can or will be converted into cash within the next 12 months. Other than a checking account, this group would include money market funds, the inventory and accounts receivable.

Long term assets, also called fixed assets, are those items not expected to be converted to cash in the next year and would be fixtures, equipment and the building the business may own.

The liabilities are divided similarly. Current liabilities are those you expect to pay within the next 12 months. In addition to the traditional accounts payable, this category would include the principle amount due in the next 12 months for any loan the business has.

Long term liabilities are those items not scheduled to be paid in the next 12 months. This would include the principle payments for loans starting with the 13th month through the end of the loan.  Interest does not appear as a payable until it is due.

The covenants that were mentioned earlier are primarily calculated using information from your balance sheet. Of major concern to a lender is the ability of your business to pay your bills over the next year. The ‘current ratio’ will give the lender a strong indication of your ability to do so.

Another concern to a lender is the relationship between how much the business owes to all of its creditors as compared to how much equity the owner has in the business. The ‘debt to equity’ ratio gives that answer.

If what you have read in this article is foreign to you, there should be a conversation between you and your accountant about what you know and what you want, and need, to know about the financial information of your business. If you know your financials, you can know how to make more money as well as how to keep your business out of trouble with a lender.

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