In the last several weeks we have examined two of the common myths that small business owners have about financial statements. Those were:
Myth #1: Financial statements are just history; I manage my business forward. The banks and tax accountants can use the financials but they aren’t much use to me.
Myth #2: I don’t really understand my financials, but they seem to keep the bank happy, so I’m okay with them.
This week we finish this series with dispelling myth #3. That myth states:
Myth #3: My financials indicate I made (or lost) money, but I don’t believe it.
Not many people say this out loud, but I wish they would, so we can help them better understand their situation. It is not responsible to allow a disconnect between your perception of your business performance and the reality because there is wonderful knowledge in understanding the difference.
First, your financials are based upon certain assumptions or accounting policies, which may be minor in some businesses and huge in others. These may include depreciation calculations, amortization, bad debt recognition, revenue recognition, tax provision computations, etc. You need to understand those policies and be okay with them. You must understand how these policies affect your profits and losses. You cannot productively discuss your financials (for instance with your bankers) without basic agreement on the appropriateness of these policies, or at least framing the conversation in the realities of how these policies are applied.
Second, it’s important to understand that profits don’t always feel like profits. Profitable businesses can and often do have negative cash flows. A vendor screaming for payments or wondering if he can make next week’s payroll doesn’t feel like profit. Similarly, cash flow issues can mask losses. Believe it or not, many businesses are awash in cash even as they fail. Receivables are collected and become cash; inventory is reduced and becomes cash while the business is literally cannibalizing itself. So, you also need to learn to understand your cash flow statement, not just your profit, and build appropriate plans.
It’s important for you to ask questions about your financial statements and how they impact your business. And, if you don’t understand the answer, ask again, persist again until you sort out where your perceptions of the financials collide. This knowledge gives you a true realization of issues so that you can fix them before you have consumed years of potential business growth.