Every year TGG’s Founder and CEO, Matt Garrett speaks with thousands of small business owners around the country. They ask him numerous financial and accounting questions, yet the same ones come up time and time again. These are the most frequently asked questions Matt has been asked:
WHEN SHOULD I RECEIVE MY MONTHLY FINANCIALS? HOW DO WE CLOSE THE BOOKS MORE QUICKLY?
You should receive your financials at least by the 15th of every month. You should strive to receive your financials before the 15thevery month so that you are able to make good, timely decisions in your business. Receiving them between the 10th to 15th is good, from the 5th to 10th is very good and before the 5th is Rockstar status.
If you’re going to get your financials before the 15th, 10th, or better yet the 5th, you’re going to need to figure out how to speed up closing your books. The first thing to do to is to focus on a ‘fast close’, which starts with reconciling your Balance Sheet every single week as opposed to waiting until the end of the month. The second thing it to use a proper purchase order (PO) process. If you start with a PO process, you’ll know what you spent money on before you get the invoice. The third thing to do is to speed up your invoicing process. Make sure that your business processes are running effectively and efficiently because it’s not only going to help you get your numbers on time, while also helping your cash position.
WHEN DO YOU EARN REVENUE? WHY DOES IT MATTER WHEN YOU RECOGNIZE REVENUE OR EXPENSES?
You recognize revenue when you earn it, meaning when you actually do the work or deliver the product or service that you’re required to deliver. For example, if you’re a manufacturing firm, the minute that product leaves your warehouse you have earned that revenue. If you’re a service provider, you earn revenue the day you provide that service. Even if you don’t send an invoice out for another 10 days, you still earned that revenue when the product or service was delivered. It’s important to understand that when you earn the money you also need to match that up with your expenses. Why? Because it tells you how your business performed in that period or month. If you don’t, you now have revenue and expenses in different months making one month look more profitable than the other. It’s very important to put revenue and expenses in the proper period every single time so you can manage your business by the numbers and feel confident that the numbers are accurate.
WHAT SHOULD MY PROFIT MARGIN BE?
It depends on which profit margin you’re talking about: Gross Profit Margin or Net Profit Margin. Nearly every business has Net Profit margins between 10 and 20 percent. Very few fall outside of that range. The challenging question is what about your Gross Profit margin? In order to answer that, you need to be more specific about your business. Are you in a unique position where you provide something extremely rare or customized? In that case, you should have very high Gross Profit margins. If on the other hand, you are in a commodity business where everybody provides it and price is the value determinate then you’re going to have low gross margins.
WHAT IS THE DIFFERENCE BETWEEN TAX AND BOOK ACCOUNTING? DOES IT MATTER?
Did you know that the IRS requires you to keep 2 sets of books? Most people think that’s defrauding the IRS, but it’s not. It’s really important to keep 2 sets of books because the IRS tax code changes constantly and is long and complex. For you to follow that versus the accounting rules that have been around for hundreds of years makes no sense. You want to pay taxes at the very minimum amount legally required by our government and you want to run your books by exactly the right accounting principles, so you know where you are and where you’re going.
WHERE IS MY CASH???
Your business is booming, sales are great, but you don’t have any cash. What’s the problem? Well there are a couple things that may be going on. First, your accounting could be wrong. It’s very important that you track profitability accurately. The second thing that could be happening is you might need to buy inventory or goods ahead of actually making the money and knowing your cash cycle. For example, if you take a 50% deposit today, and it takes 90 days to get the items back from the factory, then another 90 days to sell them all of a sudden your cash cycle is well over 180 days before you are getting fully paid. You have to make sure that you take that into account because sales could be booming, but if you don’t have the cash then you could run yourself right out of business.
HOW WILL GOOD ACCOUNTING INCREASE THE VALUE OF MY BUSINESS?
Businesses are sold on trust. Investors, strategic buyers, other buyers, private equity funds and other kinds of investors are all buying the same thing. They are buying your future earnings and the future earning potential of your business. The only way they are buying it is on trust and if you have bad accounting they are going to run away. If you have great accounting, they will have confidence in you, which builds trust in your business.
WHAT IS THE BEST WAY TO PRESENT FINANCIALS?
At TGG, we use the pyramid method. It works by thinking of it like standing at the top of a pyramid. You look out and you can see the other pyramids, landscape, etc. and as you travel down the pyramid you can start to see the blocks that made up the pyramid. As you travel down even further, you start to see all the people down that the bottom that you couldn’t see before at the top. When you get to the bottom you can see every single grain of sand that made up the pyramid. Think about it as big picture to little picture. Everything at the top you want to be condensed, but then you want the ability to drill down into the financial statements and get down into the notes and details. If you had started at the bottom you wouldn’t be able to tell if your business was successful or not. We recommend starting at the top and working your way down to present a good set of financials to management.