How Small Town Business Finances Work

by Tom Egelhoff

The rules of baseball haven't changed much in nearly 100 years. It's still 60'6" to the pitchers mound. Bases are still 90' apart. Three strikes you're out.

What has changed is how the game is coached and managed.

In the old days, when someone came to bat with men on base, you crossed your fingers and hoped the pitcher could get him out.

Today, the manager not only knows the batter's average, but his average with two outs and runners in scoring position.

He knows how the player bats against right handed and left handed pitching.

And, a host of other stats about every player on the opposition as well as his own team.

The same is true in business.

Your financial reports provide information about your business that you should be using whenever you make financial decisions.

However, the sad fact is, most business owners only look at a financial statement twice a year.

They look at the annual Profit and Loss Statement (P&L), (did we make any money?), and their taxes, (how much of our profit do we have to pay?).

Here's how your financial statements can affect your business.

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First, What Kinds Of Information Are We Looking For?

Look at the numbers, ratios and percentages and how each affects your bottom line.

In order to know if your numbers are favorable or unfavorable you need something to compare them to.

Most associations will have these "base" numbers for your industry and the formulas to calculate them.

Yours may vary from the average because of location, city or company size.

If you aren't sure of your industry numbers check the "The Small Business Source Book" at your library. Or contact your local SCORE group or the Small Business Development Center nearest you. Search by state.

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Cost of Goods Sold

Cost of goods is producing, converting or buying an item that is sold.

The formula is simple: Take total sales of all products and subtract the cost of goods along with "all" expenses and the difference is your gross profit margin.

This should be done for both overall goods and again for each product.

The individual process show's which products are "winners" and increased inventory might be considered.

Or which are "losers" and should be eliminated from stock.

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Return On Sales (How Much Do You Make Per Sale)

How much does it cost to buy a widget from your business and how much do you make?

You'll need your Profit and Loss Statement (P&L) for this one.

Return on sales shows you the percentage made on each dollar of sales.

The Formula: Divide "net" pretax dollar profits by total sales.

The beauty of this formula is it measures (in percentage) how efficiently you convert a sales dollar into profit.

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Cost-Benefit Analysis

Ever get an idea and wonder if it will work? The cost-benefit analysis will help make that decision.

Suppose you have an auto parts store and would like to expand to other cites.

If the expansion cost outweighs the income produced by each store, the move is not warranted.

Ever had a re-call on a household appliance?

Companies have to weigh the cost of the recall vs. the cost of customer good will, lawsuits and customer confidence.

The re-call may cost the company more in the long run if they don't do it than if they do.

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Could You Make More Elsewhere?

How much have you invested in your company? How much are you taking out?

Salaries, bonuses and benefits can have a major impact on any business.

Start by dividing pretax profits (P&L) by Equity/Net Worth (Balance Sheet).

This will show your return on your investment.

If it's less than 5% you could probably make that in some other investment vehicle.

If you like what you're doing...keep doing it. If not, stop working and start living.

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How Often Do You Turnover Inventory?

A retailer or wholesaler you must move inventory.

How much tells the health of your business and how well you are managing your inventory.

To calculate: divide your "average inventory" into Cost of Goods Sold (P&L).

The higher the number, the more turns you have and the healthier your business.

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Accounts Receivable

You must be paid in a timely manner. Slow pay can put you out of business. You must have a "handle" on how quick the money comes.

The first step is to compute your average sales day. You can take your total sales for the year and divide by 365 "IF" you are open all year.

If not compute the number of days you are open for business.

Next, divide that number into your current accounts receivable. This will show you the average number of days it takes for you to collect from your accounts receivables.

Less than thirty days is preferred. Thirty to forty-five days are acceptable; almost anything over 45 days may cause a hardship on your business.

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Learn To Do It Yourself

Accounting is a lot like practicing medicine. The patient comes in; you put on the heart monitor, take blood and other fluids for testing.

Then a doctor reads and evaluates the tests and arrives at a diagnosis. The patient is either in trouble or healthy.

No, I don't want you to do your own accounting. Most businesses need an accountant just to keep them out of trouble with the IRS.

Instead, learn how to read your financial statements so you know what's going on in your business. You may not always make the right decision but at least you will be making an informed one.

Return to the "Business Management" Directory

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