For 15 years, CNBC broadcast a documentary series called American Greed. While the show focused on white-collar crimes like Ponzi schemes, embezzlement, and material misrepresentation, the victim companies profiled in the series shared a common thread: They trusted what they were told and didn’t know their numbers.
Interpreting numbers on a financial dashboard remains an age-old problem for business leaders. It seems like a relatively simple idea: everyone can read numbers and do basic arithmetic. Even so, many companies are surprised when their numbers go south. So what gives?
On one level, the answer is equally simple: if your expenses exceed your income, you should expect financial problems. It’s basic math. But even when you “know” your numbers, without understanding them, you might be in for some unpleasant surprises.
Even when leaders are familiar with their balance sheets, cash flow statements, and profit-and-loss (P&L) reports, it takes context and awareness of how these figures interact with each other (and the outside world) to navigate the ups and downs of business.
In the middle of an election season, with headlines about national labor strikes, inflation, lingering supply chain disruptions, and chronic instability in energy, real estate, and foreign trade (and did we mention competitors?), now is an ideal time for a quick primer on financial literacy to ensure you understand your numbers.
The Purpose of Your Statements
Think of your three definitive financial reports as the company’s “past, present, and future.”
- P&L statements tell you what’s happened year-to-date, by month or by quarter (the past)
- Balance sheets tell you the company’s current condition (the present)
- Cash flow statements tell you what’s coming (the future)
P&L statements show how revenue and expenses grew, shrank, or stagnated in the month or quarter that’s behind you. Bravo if your revenue consistently exceeds expenses, month after month. But for most businesses, there are high and low months. Your P&L will give you a general idea of your “run rate”: recurring, fixed expenses, and the average cost of being in business.
Quick literacy tip: You don’t need to review every line item on your P&L, but a handy shortcut is to group variable expenses as one subtotal, fixed expenses as a second, and overhead as a third. These three key categories will tell you where you are spending money each month, and where you can reduce expenses if income is not keeping up. Remember: variable expenses are directly related to how many (or few) widgets you sell each month – things like cloud hosting, customer support, and payment processing fees. Fixed expenses are not directly tied to sales; they include subscriptions, advertising, marketing, and travel. Overhead is also fixed but not discretionary – think payroll, rent, utilities, and benefits.
Balance sheets give you an idea of the business’s total financial health, like a physical checkup with a doctor. This report does not show money coming in or going out; instead, it shows your total assets and liabilities as a snapshot in time. Assets include tangible property like buildings, equipment, and products in your warehouse. It also includes your accounts receivable, i.e., money due to you from clients and customers. Assets also include money in the bank and the current value of investment accounts. Liabilities are the total debt you owe and bills you’ve committed to paying. A healthy balance sheet shows assets exceeding liabilities and will please your banker. But the future will be shaped by your cash flow statement.
Cash flow statements forecast income and expenses in the future. These statements provide a week-by-week (or month-by-month) analysis of how much money your company will have on hand in its bank account so you can anticipate future shortages (and excesses), adjust activities, and prepare for leaner times – which is essential to forecast when you have ongoing responsibilities like payroll. Cash flow statements are vital to avoid those unpleasant surprises we discussed earlier. If you can’t look ~6 months into the future and anticipate revenue flowing to the business, that’s a sign to pick up the phone now and start selling. It’s also good to have a solid bank balance and line(s) of credit for emergencies.
Quick Literacy Tip: If your cash flow statement always looks rosy for the future, but your P&L is consistently underwater, you might have unrealistic expectations. Cash flow forecasting is only as good as the forecaster. Sit down with your accountant or CFO and discuss how these forecasts happen. Consider dividing future revenue into categories like “certain,” “likely,” “possible,” and “long-shot.” Then, look at your cash flow using only certain and likely in your revenue forecast. How rosy is the outlook now?
These financial reports rise and fall in relationship to one another. A poor balance sheet can erode your sales team’s finest performance and undercut even the most fiscally disciplined companies. A poor P&L means you struggle to cover current costs even if cash flow looks excellent. This can cripple growth on the balance sheet, particularly if you take on debt to maintain payroll and operating expenses. Fortunately, if you know and understand these realities, you can plan accordingly.
How to Find Your Feet Financially for Q4
Even if you’re not a “numbers person,” it’s up to you to improve your literacy and understand your numbers better tomorrow than you do today. This doesn’t mean you need to know every single digit, but it’s no time to be an “absentee” leader. Reviewing these reports regularly will help you develop an intuitive sense of when certain numbers behave like “sore thumbs” – when they stick out, recurringly, and harm your growth.
Quick Literacy Tip: When you look at any financial report, look for “outliers.” For example, if your fixed expenses are the same, month after month, and then one month they shoot up by 300% … ask why. There may be a good reason, or you might have found a canary in your coal mine.
Schedule an annual self-audit, typically in partnership with your CFO. During this self-audit, watch for recurring expenses that are no longer in use. For example, subscription services are notorious for quietly, incrementally “bleeding” funds from their organizational customers. In fairness to some of our larger partners, this audit is no small task – especially if their departments use traditional company credit cards assigned to the CEO. We use “Ramp” credit cards, a revolutionary system that issues cards to each department. These cards then roll up into a single account, simplifying the accounting department’s job of tracking and reporting operating expenses.
Finally, it may be worth hiring an outside accounting firm to evaluate and analyze your books. If you’re dealing with lingering financial issues and struggle to know where to start, impartial observers trained to analyze your organization’s financial vital signs could be what the doctor ordered.
Most importantly, spend time with your numbers each week and each month so that you become familiar with the patterns and comfortable with the metrics. You’ll make a critical investment in your company’s future, and before you know it, you will be reading financial reports like a native speaker.
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I once watched an interview with Oprah Winfrey, and it has influenced my businesses ever since. The interviewer asked her, “Have you ever felt powerless?”
“All the time,” she answered. I was shocked – this was one of the most powerful, successful women in the world! But then she started explaining strategies she uses to overcome her doubts and take control of her life. One of them was that she signs every check for her company. She wanted to know every cent going out the door of her company.
If that strategy was good enough for Oprah, I thought it would be worth trying – and I found it was worth the effort! When I started signing every check, I was able to fix errors, discover money we were spending that we didn’t need to spend, and stop overpaying for things we still needed. The more I saw the numbers, the better I understood our business.
This article from our Financial Director has great advice for business leaders who are looking to learn more about their numbers. Even if you don’t have an accounting background, taking time to understand the most important financial info for your company can lead to good things.
Fran Tarkenton
