I attended a business workshop and I was asked what the “Big One’ was for me. They were looking for the one measurement that ensures financial success. I was asked this as a business owner, not an accountant. I immediately got lost in the detail. There are a lot of measurements available, created for a number of reasons. But I was asked what was the one that would make the greatest difference and give me a reality check on my business. Then the “ah ah” moment hit. It is sales divided by compensation. We are a service business. All sales are generated from the services that we provide.
A client called me in a panic. Cash was flowing out faster than it was coming in. He hadn’t closed a new customer in 4 months. The staff was busy. He was looking at how to decrease his expenses. Even before I looked at the numbers the “big one” came to mind. His sales to compensation ratio was upside down. I asked… How do you confirm that your staff is busy doing the right things? Is your pricing in line with your costs? are you working with the right clients? I recommended that the owner focus on one number – sales / compensation. Service businesses typically have a $2 to $1 or higher ratio. Within 30 days he right sided the business. The panic decreased and the fun was back.
Once he dug into operations he discovered a few things – the staffing wasn’t right. His financial numbers confirmed that his sales/compensation was upside down. They made some corrections and things improved. Upon further review he also realized that this time of year was slow, just never to this extent. Last I heard he had 11 proposals ready to close. His April financial results were much better than March.
Financial statements and ratios can confuse readers. They can offer too much detail and are typically not in any order that is helpful to make decisions. Most financial statements for small businesses are set up to meet tax requirements or they follow QuickBooks standard chart of accounts and are in alphabetical order.
I found it is much more helpful to break it down into 3 sections – sales, direct costs and overhead expenses. Sales less direct costs is the business’s gross margin. The higher the gross margin, the more available to cover overhead and end up as profit.
Each business has the “Big One”, that one ratio that ensures financial success. For all businesses that one ratio is Sales divided by Direct costs. With service business the direct cost is compensation, for product sales the direct costs consist of produce cost, packaging, manufacturing and delivery of the product. Once the “big One” is clearly defined and understood, other measurements can be determined for each department and down to each staff person.
My recommendation is to keep the financial statements as simple as possible and as meaningful to the reader as possible, otherwise the information will not be used.
If you need assistance in redesigning or understanding what your statements are telling you please give us a call to meet with Mary to review your current situation and see how we can make your financial statements more meaningful.
By Mary Guldan-Lindstrom, CPA