The value of knowing your key financial numbers while starting and growing a new company is priceless. If you have an intimate understanding of your financial numbers, then you will feel more in control of your business and life. Also, the numbers tell you how you can make the most money with the least amount of time and effort, which should be a goal of any entrepreneur.
There are many stories of entrepreneurs who go for lengthy time periods without paying themselves or their taxes. Others find themselves paying their bills late, forcing creditors to chase them down. Many of these problems can be avoided by proper planning and discipline. You do not need to have a CPA license to do this effectively — basic math and a lot of discipline will take you a long way with this task!
What Numbers Are You Watching?
In order to accurately determine the financial health of your company, track your three most important numbers:
- Net profit. Net profit is also known as the “bottom line.” In the end, you are in business to make a profit; it doesn’t matter how many sales that you’ve made if you continually spend more than you make. To calculate this number, take your company’s total revenue and subtract your total expenses from that. [Net Profit = Total Revenue – Total Expenses]
- Return on investment. ROI is a measure of how effective you are using your capital to grow your business. To calculate ROI, just take your net profit and divide it by the total amount invested to earn that profit. So if you earn $400 on a $1,000 investment, then your ROI is 40 percent. The judgement on how good an ROI is depends greatly on which industry you are in and what segment of the market that you are serving. For example, you would not expect a large blockbuster like Transformers to have nearly as high of an ROI as an independent film that has been nominated for an Oscar.
- Cash flow. Cash flow is the movement of money in and out of your business. In the early stages of growing your company, this will be the number that you will need to track most closely. If you run out of cash, then it’s game over! I track cash flow on a weekly basis with a simple spreadsheet, with a column for the money coming in and another column for the money going out. Then, I add or subtract that number from the starting balance.
Many people want to measure financial health by the amount of sales earned, but this is a huge fallacy. Sales don’t make a company successful — profits and cash flow do. Furthermore, there is often an inverse relationship between sales and cash flow. Companies go out of business because they have increased their sales receivables without identifying sources of short-term cash influxes or by cutting their profit margins just to make a deal work.
How to Keep Track of Your Numbers
Understanding which numbers to track is vital, but so is understanding how those numbers positively and negatively impact your business. One of the best things that I started doing early on is calculating my important numbers by hand. This was part of an educational process that helped me stop seeing these numbers as an abstract concept, but instead as a concrete cornerstone of my business. I still use many of the financial accounting software tools on the market such as QuickBooks Online or FreshBooks, but it is easy for me to disconnect those reports from the current reality of my business. Also, tracking numbers by hand forces you to move more slowly and study the strengths, weaknesses, opportunities and threats facing your business.
In the early stages of your business, I recommend that you track your numbers weekly. Over time, you can scale back to bi-weekly, and then monthly. The more practice that you can get early on, the better. I once lost control of my company during the early stages of its development because I wasn’t properly tracking and understanding my financial numbers. This loss of control resulted in unwise decisions, because we were struggling to simply stay alive!
Understanding your company’s financial numbers in the early stages will raise the likelihood of business growth and reduce the likelihood of company failure.