As I talk to contractors who have encountered serious financial challenges in their businesses, one of the recurring reasons is a lack of financial oversight. As they begin to recite the litany of business mistakes and think about what got them into a financial mess, the top of the list, almost without exception, is a lack of financial oversight.
Now, core business challenges are normally due to marketing or operational issues - not necessarily financial issues. Something changes in the way we source and retain customers (marketing) and sales start to decline. Or on the operations side, the cost of serving customers gets out of whack or overhead grows much faster than sales, leading to financial challenges. There are many reasons why a business struggles.
However, the growing marketing or operational problems were hidden from view due to poor financial information or lack of financial acumen on the part of the owner.
When it comes to financial oversight on the part of the business owner, there are five common mistakes that are made - any one of which can cause a financial disaster in your business. I hope none of these sound familiar.
1. Letting someone else understand the numbers.I see this all the time. An owner is confused on how to read a balance sheet and income statement. He may be intimidated by all the numbers or even a little embarrassed by his lack of financial acumen. So instead of tackling the problem head-on and learning how to read and interpret financial information, he retreats even further into the field, into doing the things he is comfortable with, such as selling work or helping out on jobs or, worse yet, working on rental property or other business interests that he enjoys more.
If he is extremely lucky, and I mean one-out-of-a-thousand lucky, he has a trusted employee who does keep a watchful eye on the income statement, balance sheet and daily cash balances and tells the owner what needs to be done. If you truly have an employee like this, understand you have hit the lottery.
If you aren’t lucky and no one is watching the numbers, your company is a future financial train wreck.
Keep in mind, it is a very rare business owner in our industry that starts a business with a sound financial background. Almost without exception, successful companies in our industry are run by sound tradesmen who developed solid financial oversight skills over time. Financial literacy and oversight can be learned and must be done if you are to enjoy long-term business success. Don’t delegate financial oversight to someone else in your company. Learning how to read and interpret your company’s financial information should be your first priority.
2. Not insisting on accurate financial information.Through all of the profit-and-loss reviews I have done, I have lost count of how many times I have pointed out a number on an income statement or balance sheet that is out of line and hear, “That number is not right” as a legitimate excuse to not worry about it. The best advice I can give you is if a number is not right, worry about it! Then insist that the number is corrected with the revenue or expense put in the proper spot.
The financial statement should be an accurate reflection of the month and year’s operating performance. The balance sheet is an accurate point-in-time snapshot of the financial health of the company. The key word is accurate. Don’t let this expectation slide. Whomever is responsible for the financial reporting activities of your company must get this right. If that person can’t or won’t provide you with accurate financial information, get someone else to do it for you. End of debate.
Here are some of the common mistakes that can’t be tolerated:
- Field labor and office salaries are lumped together.
- The payroll expenses do not match the revenue period (not accruing payroll to match the same days of the month as revenue).
- Depreciation expense is not entered monthly.
- Revenue, direct labor and materials are not properly departmentalized (plumbing service, new construction, etc.).
Get all of your revenue and expenses in the right bucket. This will help you make good and timely decisions. Which leads right to the next financial mistake…
3. Not insisting on timely financials.In a large company with a professional finance department, there is one absolute rule. The prior month’s financial statements will be ready on a set date. That date could be the 10th of the following month or six business days into the next month. There is no wavering. Excuses such as, “I was busy” or “I had to pick up my kids from school and help with a school project” are not accepted as legitimate reasons for not getting the business operator’s accurate financial information in a timely fashion. This one is nonnegotiable. If you have to work until midnight, you work until midnight to meet the deadline.
In small, family-owned businesses, there is rarely the same absolute rule on when the books for the prior month should be closed. I have seen a few days late turn into weeks late, which turns into months late. All the while, the only financial measurement a business operator has is the bank balance. “If there is cash in the bank things must be good,” or so goes the thinking.
Whomever is responsible for the financial function in your company must put accurate and timely financial information in your hands. I understand that small businesses have less resources and more additional responsibilities than a large company with dedicated financial personnel. Take all this into account and then set a realistic but firm date each month when you want the company’s financial information to be in your hands. Don’t let it slide and don’t accept a missed deadline.
Once you start to get timely financial information, review it in detail the day you get it. Don’t be the one that allows a timely financial review to slide because of other priorities.
4. Ignoring everything in the middle (expenses).For many contractors who have a certain measure of financial literacy and are receiving and reviewing a timely and accurate monthly P&L/balance sheet, they take a quick look at the top-line sales and the bottom-line profits. If the company made a profit, that is where the analysis ends. There is no review of key percentages of sales such as direct labor or material, no review of key overhead expenses (such as vehicle expenses, advertising or office salaries) to see if the business is growing or declining.
What they are missing are harmful trends that strong revenue months or years can hide. Wise contractors are always on the lookout for negative financial trends, especially during good times. They pore over financial information to make sure they catch negative trends before they become big problems. Key financial statistics you should be watching are:
- Growth in accounts receivables more than 30 days.
- Direct labor percentage increases.
- Material percentage increases.
- Vehicle, office salaries or advertising expenses that are growing faster as a percentage than sales.
5. Not comparing financials to prior periods/budget.This is all too common. A company is struggling and I ask to see an income statement. The owner then forwards to me a single-column statement out of QuickBooks. No percentage of sales column. No prior-year comparison and certainly no comparison to budget.
What he is lacking is a point of comparison. Is the company getting better or worse? Why is it getting better or worse? Is it because sales are up or down compared to last year? Is it because direct costs (direct labor or material) as a percentage of sales are increasing or decreasing? Is it because certain overhead expenses have increased or decreased?
If you don’t have a good point of comparison, you have to go on gut feelings and memory. This is not good, especially as your business grows and becomes more complex.
At a minimum, you want to compare each month against the following:
- Prior year, same month.
- Current year-to-date.
- Budget for the month.
- Budget year-to-date.
And don’t forget to always include a percentage of sales column for all revenue and expense items. In particular, you want to focus on the percentage change for revenue and direct costs.
Becoming financially literate is not a difficult task. It will not happen overnight. However, your knowledge will build each month if you avoid these mistakes and take it upon yourself to become the financial overseer your company needs.