Because my company Maui Mastermind works with so many business coaching clients, we’ve gained a deep perspective on business owner trends and patterns.
One of these “patterns” is how prevalent it is for a business owner to not fully understand the financial pillar of his or her company.
This is most obvious with respect to their own financials.
Take this simple 10-question “pop quiz” to give you a good sense of where you stand with respect to your financial sophistication to run a business.
Because only you will know how you do, answer these questions in writing (ink preferably so you don’t “edit” later.) All kidding aside, this quiz is simply a tool to help you identify financial holes in your knowledge base that you need to fill in over the coming months to be a better, smarter, more successful business leader.
The questions are listed at the top, then after I go through each question a second time giving you the “answer” and a few thoughts on what the question reveals about your financial savvy.
- True or False: The more a company sells, the more it earns.
- True or False: The best way to stay on top of collections is to collect 100% payment for your product or service immediately upon delivery.
- True or False: “Cost of Goods Sold” is an Income Statement line item that applies only to businesses that manufacture or “make stuff” (i.e. have inventory, raw materials, etc.)
- True or False: Your company’s gross profit is a measure of how efficiently your company produces your product or service.
- True or False: If your gross profit margin is too low that means you are not efficiently producing your product or service.
- Which of the following are “expenses” on your “P&L”?
- Salaries
- Travel
- Loan pay down (i.e. amortization of the loan)
- Rent
- Inventory
- Depreciation
- True or False: My company’s pricing is too low.
- True or False: The best way to determine pricing is to look closely at your costs and your competitors to make sure you all your products and services are both profitable and competitive.
- True or False: If your P & L statement shows a profit of for the year of $1 million then you don’t have to worry about covering your payroll check run next week.
- True or False: When you have a cash flow challenge, the first thing your company needs to do is to immediately buckle down and focus on increasing sales.
ANSWERS:
Okay, now that you’ve written down your answers, here are the answers I think are most accurate and some key coaching for you on what I hope you take away from each question.
- True or False: The more a company sells, the more it earns. Many companies aren’t even aware that on some or even most of their products or services they are selling at a loss. I can even remember one CPA firm we coached that was shocked when we showed them that they had roughly 1 in 3 clients whom they were at a negative gross profit on to service that work. That meant that they were actually paying money (i.e. covering a loss) to do the work for the client. These clients were being subsidized by the other profitable clients of the firm.Here’s an earlier article I wrote on 5 ways to increase your profitability.
- True or False: The best way to stay on top of collections is to collect 100% payment for your product or service immediately upon delivery. The BEST way to stay on top of collections is to get paid before you have “cost of goods sold” either by collecting up front in full, or getting a “retainer”, “deposit”, or whatever you call it in your industry.
- True or False: “Cost of Goods Sold” is an Income Statement line item that applies only to businesses that manufacture or “make stuff” (i.e. have inventory, raw materials, etc.) Even service businesses have Cost of Goods Sold. In their case, it is the cost of producing and fulfilling on their service offering. Likely it includes labor, materials, and sometimes even a proportional share of the overhead that is dedicated to the staff that are primarily or exclusively “billable.”
- True or False: Your company’s gross profit is a measure of how efficiently your company produces your product or service.True. Had to keep you on your toes. Your “gross profit” is what you have left after you take your total sales and deduct the Cost of Goods Sold. It is a great indicator for how efficiently your company produces your product or service offering, relative to your pricing. It is also one of my most favorite clues as to the health of a business, and one that is consistently ignored or misunderstood by most business owners.
- True or False: If your gross profit margin is too low that means you are not efficiently producing your product or service. It may mean that you are not efficiently producing your product or service, but it may also mean that your pricing is simply too low. If you’re confident that you’re pricing is right, then a low gross profit margin likely means your Cost of Goods Sold is too high.
- Which of the following are “expenses” on your “P&L”?
- Salaries
- Travel
- Loan pay down (i.e. amortization of the loan)
- Rent
- Inventory
- DepreciationExpenses on your Profit and Loss Statement:
a) Salaries (except for those salaries of people involved directly in producing your product or service, in which case, their salaries or wages would be part of your “Cost of Goods Sold” and hence show up higher on your P&L.b) Travel
d) Rentf) Depreciation (at least that year’s depreciation. The cumulative depreciation will show up on your Balance Sheet.)
Notice that “loan pay down” is not an expense. Yes it costs cash, but it shows up as more equity on your Balance Sheet as you reduce the liability (i.e. loan).
Same is true for “inventory”, it is a balance sheet item until the time you sell the inventory or write it off.
One way business owners get themselves into trouble is they think their P&L “profit” is the same thing as “cash” they can spend. It’s not. More on this in a moment.
- True or False: My company’s pricing is too low.Most likely true. In my experiences working with over a thousand companies, 7 out of 10 companies with sales under $10 million per year could and should raise their prices.
- True or False: The best way to determine pricing is to look closely at your costs and your competitors to make sure you all your products and services are both profitable and competitive.False. The best way to measure pricing is to price in relationship to the cost (pain) of the problem your solution solves for your customer, factoring in how immediate you provide that solution, and how difficult it is perceived for the customer to get this or an equivalent solution from someone else. Wherever possible, don’t price as a commodity, instead price as a value provider who brings something special (perhaps even unique) to the table.
- True or False: If your P & L statement shows a profit of for the year of $1 million then you don’t have to worry about covering your payroll check run next week. As noted earlier, this often gets business owners into trouble. You P & L hints at cash, but doesn’t tell the whole story. You have phantom expenses like depreciation that show up as “expenses” on your P & L, even if the cash left your business three years ago when you made the asset purchase. You also have cash expenditures that don’t show up on your P & L until later. For example, inventory. Your Cost of Goods Sold may have diminished your bank account by $100,000 or more, but you can’t show it as an expense until you sell that inventory (or write it off.) And perhaps the biggest culprit of all, you may show “sales” of $100,000 this month, but if you’ve only collected $10,000 of it you still have to get the other $90,000 before you have the money to spend. This is why you need to get fluent with all three of your company’s financial statements: Your “P&L”, your “Balance Sheet” and your “Statement of Cash Flows.”
- True or False: When you have a cash flow challenge, the first thing your company needs to do is to immediately buckle down and focus on increasing sales.False. The first thing you need to do is pause for a moment to determine what the root cause of your cash flow challenge really is. Is it a collections issue such as slow paying clients or non-paying clients? Or a pricing issue? Or out of control expenses? Or is it really that you simply need a larger base of sales over which to spread your overhead so that you can return to a better cash position? Once you determine the cause, then you can take smart steps to correct the situation.
For more ideas on growing your business, including a free tool kit with 21 in-depth video trainings, several of which are on understanding the financial pillar of your company, and all of which will help you scale your business and get your life back, click here.