How useful are your financial reports when it comes to managing your business?
If you said “very useful,” congratulations. You are one of the few small business owners who can say that.
For everyone else, here are 3 mistakes you are probably making that prevent you from running your business as well as you could.
Each of these mistakes and fixes applies regardless of how you keep your books. Since most small businesses use Quickbooks, that is what I’ll talk about in the examples of how to fix the problems.
Use the suggestions below as a staring point. Your accountant can help you understand best practices and accounting standards for your industry.
Mistake #1: Not organizing your books to reflect your business
Your financial reports are important management tools. But they will only work if you set up them correctly.
In Quickbooks, the default output of reports is to list all the accounts alphabetically. Most people never change this. That leaves you with a jumbled mess of a list that is near impossible to make any sense of.
No wonder you get a headache at the thought of looking at your financials.
What to do instead
Re-organize your chart of accounts so that they reflect how your business actually operates.
At a minimum, you’ll want to create two main expense categories:
- Cost of goods sold (or cost of services)
- S,G&A (Sales, General, and Administrative)
Most likely you will want to create several more. I’ve listed some top-level expense categories below. You may want to split things up even more.
Within each of these categories, you can have as many sub-categories as needed to track expenses.
Cost of Goods Sold/Cost of Services
This category includes all the direct costs you incur to provide your product or service. If you sell products, it includes your cost to purchase or manufacture them. If you sell services, it includes direct costs and the labor costs to deliver the service.
This category is important because it lets you calculate your gross margin, the amount of money you have left to cover your expenses.
Marketing & Sales
This category includes all your expenses for advertising and selling. You track the cost of all your business development activities here.
Some sub-categories might include:
- each of the various advertising media you use
- networking events or trade shows you attend
- travel and entertainment expenses related to sales
By tracking expenses in this category, you can understand how much it costs you to acquire a customer.
Operations
The Operations category includes all the general expenses of the business that don’t fall into cost of goods sold or marketing. This includes things like:
- Rent and utilities
- Insurance
- Salaries
- Office supplies
This category lets you see how much your overhead expenses are costing you.
If you do nothing else, do this. It will greatly increase your understanding of where your money is going.
To set this up in Quickbooks, you need to edit your Chart of Accounts.
- Either Edit an existing account or create a new account
- In the dialog box, select the type of account (expense, income, etc) that applies.
- To create sub-accounts, check the box next to “sub-account of:” and select the account you want your account to be under. You can nest accounts as deeply as makes sense. At a minimum, you will have two levels. In practice, you’ll probably end up with three levels worth of accounts.
Once this is set up, be sure to always enter transactions in the lowest level sub-account. Quickbooks will roll-up all the entries into the higher level accounts.
Mistake #2: Not looking at expenses as a percentage of sales
Knowing how much you are spending in each category alone can be a powerful management tool. But it is difficult to understand how things are changing over time if you only look at raw numbers.
What to do instead
Simply calculate the percent of sales for each of your expense categories. You can easily track performance over time and quickly see when something is getting out of whack.
The great thing about looking at percentages is that you can compare against past performance. If you just look at the raw numbers, you might see that your cost of goods sold is much higher this year than last year. If your sales are much higher than last year, this is expected. if not, it could be a problem. Looking at it as a percentage makes it easy to know what you are dealing with.
In the first case, the actual cost may have gone up, but the percentage of sales is about the same. That tells you everything is ok.
In the second case, your costs have increased. You had better either raise your prices or cut costs someplace else to compensate.
The same idea applies to all the other categories. You can look at past data to see what is “normal” for your business. Then you can easily compare your current performance against “normal” to understand how you are doing.
Using percentages is also a good way to budget expenses. You can set your marketing budget at 10% of sales, for example. Then you can track if you are spending enough (or too much). Budgeting this way builds in adjustments for actual performance. The percentage adjusts the actual spending so you are spending within your means.
This is easy to do in Quickbooks.
Once you open a report, click on “options” and then check the box next to “% of income” in other columns.
Mistake #3: Not looking at income and expenses by products or location
By default, your books show the overall performance of the business. This is important, to be sure. But it’s of limited usefulness. To really understand how the business is performing, you need to be able to look at the parts.
For example, if you have two locations, you want to be sure that both locations are performing well. If you have multiple product lines, you want to know if they are all profitable.
What to do instead
Create Classes in Quickbooks. You can have one class for each location or each product line. Then, you can look at reports by class.
The standard financial reports are one-dimensional (total only by category). Adding this makes them two-dimensional (category by class).
Do do this in Quickbooks, open the report and click on “options.” Select “Classes” from the “columns” dropdown menu.
Take your management to the next level
Make these three changes to how you look at your financials and you will gain a lot more insight than you have today. That insight lets you make better decisions and not get blindsided by problems.
Your accountant can be an important partner in setting these changes up and helping you understand what the results mean. Make an appointment to talk with them as the first step.
If your accountant is focused only on tax preparation, then seek out other professionals (like a coach :)) to help you.