Management: Five Key Questions
By Gene Siciliano
challenging economic environment, it’s more important than ever for
entrepreneurs and small business owners to have a firm grasp on
financial management. When all is said and done, there are a handful
of financial management questions that every owner should always
know the answers to after the business financials have been put in
the drawer for the month. Here is my list of the five most important
small business financial management questions. Notice that I ask
the questions but I don’t provide the answers, because none of these
are “one answer fits all” questions.
1. How much profit do you really make on each of your 10
Why is this
question so important? Because the profit you make on those big
customers determines in large measure the profitability of your
how often they buy, how large their orders are and how quickly they
pay. Those are the obvious things, but also consider the special
price concessions you might give them in appreciation for their
business. Do you extend special services to them in delivery,
warranty support or other customer service? Do you extend payment
terms or wait longer before you call their Accounts Payable? Do you
process special turnaround orders or accept smaller orders than you
really want to?
these extras cost your company money or time—both real costs of
servicing that account. This is not to say you shouldn’t do it, but
you should know how profitable that account is in order to make the
best decisions for your company. My point: Your largest customer
isn’t always your most profitable customer.
giving these concessions because you’re building a relationship that
you hope will pay off “later”? If so, ask these customers if they
will be willing to pay you more money tomorrow for something they’re
paying less money for today. Want to guess their answer to this
2. How much does each product you sell really cost you?
is, if you lose money on every item you sell, it’s really hard to
make it up on volume. I am amazed at how many companies figure their
all-important Gross Profit on a product by deducting from the
selling price only the direct costs of manufacture or
purchase. Often this is calculated for an entire department, or even
entire factories, rather than for the individual product itself.
Unfortunately, this is rarely the true cost of a product you sell.
Consider the costs to receive, package, warehouse and deliver the
product. How about servicing the warranty on its performance, or the
development cost if it’s your proprietary product?
there’s the overhead cost of running your plant or warehouse. The
costs related to having the facility ready and manned for
operations range from the lights and extra insurance to the stock
pickers’ wages, the janitorial service and maintenance contracts on
your equipment. If one of your products requires a disproportionate
amount of overhead costs, an average overhead calculation for your
company as a whole will never give you the right answer. Your most
popular item could be a loss leader without your even knowing it.
3. How quickly does your inventory revolve, or turn over,
during a year?
Funny things happen
to inventory that doesn’t move out of your warehouse pretty quickly.
It disappears, breaks or becomes old, obsolete or generally
unusable. Or it just gets misplaced or lost, to be found soon after
you’ve bought more. Or the market price comes down and you have to
mark it down to sell it. All of these results take money out of your
pocket without giving you any benefit in return.
step in preventing all these things from hitting your bottom line is
to know how quickly your inventory turns and to note any changes in
that rate. This is step number one in preventing inventory losses,
to be followed closely by step number two: refining the overall
turnover rate to an item-specific turnover rate, at least for
high-cost items. Why the detail? Because expensive items that don’t
move may be hidden by fast moving commodity items on your floor
that have much lower margins.
4. How quickly do your receivables get collected?
sounds like a no-brainer to most business owners, but ask yourself
this: What is the average days’ sales in your current accounts
receivable balance (often called DSO)? Need to look it up? Too often
we believe the concept but don’t follow the practice. Collections
get out of hand without our realizing it, because we’re busy
selling more and “managing the growth.”
it this way: Decide how much interest-free money you are
willing to lend to your customers as a percentage of sales, and
stick to it.
Follow the trend of
your DSO and take action when it starts moving in the wrong
direction. If strong margin gains are available in return for
extending terms, that’s OK, but do this deliberately, not
accidentally. As a follow-up, watch your accounts receivable aging
trends as well, because old balances look the same as new balances
in a DSO calculation—and it’s statistically proven that the older
those balances, the less of them will be collected.
5. If your business does what you expect it to, when will
your cash reach its highest and lowest points of the year, and
roughly how much cash will that be?
Everyone seems to
agree they’d like to know these answers in order to better plan for
short-term borrowing needs or explore investment opportunities in
advance. And yet few small business people believe they can get the
answer in any way that’s reasonably reliable or cost-effective.
track cash flow by following net income and the bank balance,
neither of which is going to be very useful in predicting future
cash needs for most businesses. Capital asset purchases; growth in
inventory, receivables and payables; debt service; capacity
expansion—these can all have a profound influence on future cash
balances. The good news is that all can be reasonably predictable
with a little work.
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