Common-Size Your Quarterly Financials to Track Your Business’s Health
Last year is over, and a new year is underway. How did it go? Do you know if you lost money, broke even, or made money? For some, that may sound like a silly question, but you’d be surprised at how often owners don’t know how their business is doing until they have year-end reports in hand. They simply aren’t paying attention to the overall health of their business. Sure, owners probably have an idea in their head of how things are going, but when those year-end reports come in from CPAs, they simply sign off and file it away. This isn’t because they don’t care. Business owners are often so busy working in the business that they aren’t taking time to work on the business. Does this describe you? Tracking the health of your business is essential and provides valuable insight to owners allowing them to manage current and future business strategies.
Buyers Look for Profitable Businesses
Remember that there will be a time when it will be necessary to step away from your business and while buyers look at a variety of things when considering a business, above all else, they want to buy a business that is making money. Few are willing to buy a “fixer-upper” business. The proof of profitability is in the financials and a buyer will be looking for evidence of how your business fared from year to year and why.
It can be a red flag for a buyer when the owner can’t explain how their business is doing or why there might be big swings in revenue and/or expenses. Sometimes business owners run the business in their head and not on paper, which may make it challenging to recall why numbers fluctuated in a particular year. If reasonable answers can’t be backed up with documentation, a buyer might assume that the owner is hiding something and walk away from the deal.
Tracking Health and Profitability
An easy way to keep track of your business’s health, especially if your business is growing and the dollar amounts are changing from year to year is to “common-size” your financial statements each quarter that is convert your dollar amounts to percentages.
Here is how you do that: Look at the assets on your balance sheet and beside each of the line items, show that figure as a percent of total assets. Then look at the liabilities and equity and beside each of the line items, show that figure as a percent of liabilities + equity. Now consider the line items on your income statement (P&L) and show each line item as a percent of sales. It should look something like this:
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Now you’re ready to compare these new percentages: quarter to quarter and year to year to see how things are going. If you see any major deviations, document the reasons why. Common sizing also helps buyers quickly compare your business against others they are considering and, if other business owners hasn’t common-sized, then you look far better for having your act together.
While it can take some extra time to do this, and may not be part of your current practice, reviewing your financials regularly and documenting the reasons behind any major fluctuation will make a huge difference in how you make decisions to grow your business. Plus, when it comes time to sell your business, buyers will be attracted to a business they can feel confident about because they can easily understand your past history.