Written by: Roger Scherping
I met another company this week whose situation really illustrates the importance of understanding the numbers of your business. It is a service business, and they told me they were in a cash crisis. They also told me that they were on the verge of very rapid growth thanks to a new product that they were in the process of launching. They did not want to borrow any money or take on an investor during this cash crisis if they did not need to, but they were not even sure if they needed any money.
Where to Start?
The first thing I did was an assessment of where they were at financially. For that I reviewed their financial statements and asked a lot of questions. I found that their statements were only fairly accurate. They were missing some important information, like equipment loans, amounts owed to vendors, and a breakdown of the most recent sales by product line. I put together a business projection through the end of the year and made adjustments for the missing information.
I found that things were tight, but I really did not think they were in a cash crisis, primarily because they had a significant cash balance. They talked like they were not comfortable without a significant bank balance. I explained to them that it is not at all uncommon for a growing company to have very little cash in the bank and struggle with balancing the demands of vendors, lenders, and paying their employees. I told them that based on their more accurate numbers, it did not appear to me that they had a crisis that would require a quick infusion of outside cash.
So then I asked them about their new product. It was a subscription-based service, and they had not only developed an effective online sales presentation for it, but they also had already begun to generate sales from it. The sales were actually quite impressive for the short time they had been working on it. I asked them to explain to me how the subscriptions worked, and then I modified the business projection to include the impact of this new product. I put in the projected subscriptions they thought they would sell, assumed a customer retention rate going forward, and calculated their projected sales by month.
I showed the owner how quickly this new product scaled up in revenue, and he said that the projection confirmed what he intuitively thought the new product would do. This is common with non-financial entrepreneurs. They understand their business very well, and they have an amazing ability to intuitively understand, for example, what a significant new product like this can do for their business. But most of them lack the financial or accounting skills to convert their thoughts to actual, demonstrable numbers, to model what they think will happen. This is what we mean by understanding the numbers of your business: being able to document their assumptions and calculate quantifiable results that they can use to guide their decision making.
Then I was told that there was a second part to the new product. There was an additional revenue stream that would come from these new subscriptions. I took down the new details and modified the projection again to account for this additional revenue stream.
Both the owner and I thought this second revenue stream would be much less significant than the subscriptions themselves, so imagine our surprise when the model showed that the revenue from the additional revenue stream was projected to far exceed the revenue from the subscriptions! So I guess even a talented visionary owner cannot always intuitively understand the impact of their business decisions. That is why it is so important to really understand your numbers!
Our priority now is to launch the new product line as quickly as possible to increase sales and improve cash flow. If all goes as we projected, we will not need any outside money and can work our way through the rapid growth while successfully balancing all of our cash demands. I will also work on improving our financial reporting, especially real-time cash reporting, because better information on exactly where our cash is at – and anticipating where it will be – will help us keep tighter control of cash and help things run smoother.
Conclusion: Understand Your Numbers
This example shows why it is so important to really understand your numbers, and not act just on intuition. A clearer view of the future makes your decision making easier. Understanding the numbers of your business also means making better business decisions because you understand the financial impact of your decisions. So stop acting on intuition alone. Understand your numbers!
ProjectionSmart was created to do just that. Try it for free, and you will see how easy it can be to see your financial future.
About the author:
Roger Scherping has many years of financial and general management experience in small companies. As CFO, COO, general manager, or president, he has successfully grown companies of up to $20 million in sales. Many of these companies were in trouble, and he turned them around and created for them a path for profitable growth. Roger’s expertise is in financial management, business planning, managing and fixing small businesses, and financial modeling.