Basic Business Cents
Don't Drive Your Business By Only Looking in the Rear-view Mirror
by Lou Schultz, SCORE counselor
Original publish date 10/2013 (#25c)
Many small business owners have a view that they don't want to get bogged down in financial stuff, they just want to do their thing. Managing the financials is their "thing" now that they own the business.
They think that their bookkeepers and/or accountants will take care of the financial work. The information provided by their accountants is about what is already done. It has happened and it is too late to make changes. They need to see forward.
The three basic friends of financial management are the Income Statement, Balance Sheep, and Cash Flow Statement. Software is available to make this fairly easy.
The Income Statement, or Profit and Loss Statement, basically shows the revenue by major category minus the expenses by major category, which reveals the net income over a specific time. The purpose of the Income Statement is to show managers and investors whether the organization made or lost during the period reported.
The Balance Sheet is a summary of the organization's financial condition. It contains current and fixed assets, current and long-term liabilities, and the difference which is the owner's equity. While the Income Statement is over a period of time as a month or year, the Balance Sheet is at a single point in time as end of year or quarter.
The Cash Flow Statement reflects cash flow resulting from operating activities, cash flow resulting from investing activities, and cash flow resulting from financing activities. It shows the viability of the organization and its ability to pay debts, it is useful to determine whether payroll and other bills can be paid and whether the organization is financially sound. Obviously, lenders investors, and owners are very interested in this report.
As useful as these three tools are, they are a reflection of what has happened in the past. Management must predict the future. The Pro Forma Financial Projection shows potential of expected income, costs, assets, or liabilities in relation to some planned or expected act or situation. By taking the information on the Income Statement and then predicting results for the next year by month and the following two years by quarter, you have a tool that is extremely useful in making management decisions. It is a prediction that is fine-tuned each month as it is updated. Like any theory that is supported or disproved with data, it improves with use.
Myron Tribus once said, "Making management decisions by looking at the financial numbers alone is like driving a car by looking in the rear-view mirror." The Pro Forma Financial Projection allows us to look forward and see the impact of our decisions. A peek into the future will help avert disaster and allow us to take advantage of opportunities. It will help avoid looking in the rear-view mirror and thinking what might have been.