In today’s fast-paced and ever-accelerating world, we are often burdened with more work than we think we can ever accomplish. Because of the time crunch we feel, we don’t give our financial statements the attention they deserve. Often, we check the bottom line and, if satisfied, simply file the statement away without further thought.
The problem with not scrutinizing a financial statement is that you miss profit and cash-enhancing opportunities. This month, we provide you with a ten-step technique that will enable you to derive the critical information you need from your statements in less than 20 minutes. The payoff for your diagnosis time invested each month will be the opportunity for actions that will substantially increase your company’s cash position and profit.
Step One – Analyze your company’s volume trends. That’s right. Before you can understand your financial statement, you should know what your volume was for the month. More volume should equal higher profits and vice versa. Knowing the volume trend will determine your expectation for profits. If volume is down, determine why and what, if anything, you’ll do about it. If volume is up, pat yourself on the back and go on to step two.
Step Two – Check the company’s overall gross profit and cents-per-gallon gross profit. Compare the results to last month, or if your company is cyclical, to the same month last year. If the cents-per gallon profit is down, determine why by examining the individual product categories (i.e. gas, diesel, inside store sales, lubes, etc.) Is there one culprit? Or is the down-trend pervasive through all products? If so, was this caused by supply problems or competitive pressures?
Step Three – Determine the month’s operating profit before depreciation and officer’s salary in both dollars and cents-per-gallon. Compare the results to your gross margin trends to immediately know if expenses are rising or being trimmed. Also keep in mind that when volumes are increasing, operating profit should go up on a cents-per-gallon basis. If volume is up, but cents-per-gallon profit is the same, you’re actually losing ground.
Step Four – Here’s where you finally get to look at your bottom line with one adjustment. Look at the bottom line before depreciation and officer’s salary. Also, remember to review both the dollar amount and the cents-per-gallon profit. Since you already know your volume trends, gross margin trends, and expense trends, the bottom-line will be more meaningful. If operating profit is up, but net profit is down, review your non-operating income and expenses.
Now you are ready to quickly analyze your balance sheet. With just six more steps, you’ll have a complete overview of the month to make informed management decisions.
Step Five – Check your cash position minus any borrowing on your bank line. This is what Meridian calls your True Cash Balance. Compare this amount (even if it’s negative) to last month. Is the trend positive or negative?
Step Six – Check your accounts receivable collection time by dividing the A/R balance on your financial statement by one day’s average sales for the same period. (Monthly financial statement sales divided by the number of calendar days in the month.) Compare this figure to last month. How’s the trend? You want the collection time to be the least number of days possible — ideally only a day or two more than your company’s terms. Accounts receivable slowness is a prime source of declining True Cash Balance.
Step Seven – Check your inventory supply on hand. Divide your inventory balance by one day’s average cost of goods sold. Again, lower is better and watch for trends. Particularly with store chains, excess inventory is very detrimental to cash flow.
Step Eight – Check whether you are maximizing cash flow through optimal use of trade supplier credit. Divide your A/P trade balance by one day’s average cost of goods sold. The result will be the number of days it takes you to pay your suppliers. Here, more is better! (Your trade suppliers are essentially free cash.)
Step Nine – Check your asset leverage and utilization. For leverage, divide the book value of your fixed assets by the sum total of your company’s term debt (any loans other than your working capital line of credit). Leverage above 75% is considered risky. Leverage less than 50% means you may not be using financing to grow your business to its best advantage.
For asset utilization, annualize your month’s bottom-line profit and then divide that number by your company’s total assets. You should be receiving at least 5% on your assets. If your result is lower than 5% or headed downward, determine why.
Step Ten – The last step is to determine the amount of owner’s equity you have in your company. Divide your net worth (stock, paid in capital, retained earnings, etc.) by your total assets. To keep creditors happy, this number should be 25% or more.
By utilizing these ten simple steps each month, you will have a wealth of information about your company’s financial trends and position. By isolating problem areas, you will know exactly where your time and energy need to be spent to make improvements in cash and profits. (Utilize back issues of MFA for tips on specific problem areas.)
Think of your financial statements as after-the-fact measures of your company’s efficiency. As Edwards Deming would say, your financial results are a mirror of your current system. You are getting exactly what your system is set-up to deliver. If you want to change the results, you must change your system.