Understand Your Top Financial Documents
Consultants and business coaches regularly insist that, in today’s market, shop owners must manage their businesses by the numbers. While it’s no secret that your accounting and management systems can generate a wide variety of reports, understanding those financial documents and the information they reveal for your business can be difficult.
“Not enough shop owners know why these documents are significant to their businesses,” says Larry Edwards, founder and president of Edwards & Associates Consulting, a profitability consulting firm for the collision repair industry.
To get started, Edwards says that understanding your income statement, statement of cash flow and balance sheet can help you paint a 3-D picture of your business.
“You want to pay attention to all three,” says Edwards. “The balance sheet is a snapshot of the business from the past month, the income statement is a recap of the business from the day it started up through today, and the cash flow shows how healthy your business is projected to be over the next six weeks.”
Edwards and Elainna Sachire, president of Square One Systems, a management and facilitation services company for the collision repair industry, details what those three financial documents mean, the information they reveal, and how to use them in your shop.
Document #1: Cash Flow
To put it simply, Edwards says that “cash flow” is a simple measurement of the projections of cash going in and coming out of your business. The information on the report is categorized into business operations, investments, and financing activities.
“My philosophy is that profits are good but cash is king,” says Edwards. “My financial statement can show that I’m profitable but I can be completely out of cash.”
A rough cash flow calculation is the income or loss from the business, with depreciation and interest expenses added back in. On one side of the ledger, the report will detail the amount of bills due in a certain week, while on the opposite side of the ledger, it will show the invoices or sales due to be paid to the business that week.
“If you’re making money, you’re going to have more money coming in than going out,” says Edwards.
He says he likes to see the “125 percent factor.” If a shop has expenses of $100 a month, the cash coming in should be $125 a month.
The key to maintaining a good cash flow report is to be diligent about inputting every bill and invoice, Edwards says.
“If you’re using something like Quickbooks, one of the things you have to keep in mind is that their reports don’t always pull all of the data,” he says. “It doesn’t have any information that has not been entered. If you haven’t entered all of the bills and invoices, then your cash flow report isn’t going to be of much use to you.”
For example, Edwards says it is important to enter generated payables that don’t need to be paid for until a later date, jobs for which you haven’t been paid yet, and payroll.
“I can look at this month’s statement and it can say I don’t have any bills due this month, but two months from now, you’re going to have to pay that bill you didn’t enter,” he says.
Edwards recommends looking at your cash flow on a weekly basis and projecting it out five to six weeks to see how much cash is coming in and what it will be used for.
Document #2: Balance Sheet
According to Sachire, the balance sheet is one of the most underutilized financial documents by shop owners.
“The first thing shop owners do when they get their financial statements is go right to the last line on their profit-and-loss statement,” she says. “There is a huge problem with that. The balance sheet will tell you the health of the business. I can look at someone’s balance sheet, peruse it very quickly and tell in 30 seconds the health of that business.”
The balance sheet is a document that lists the assets, liabilities and equity of your company at a specific point in time. Within those categories, it shows how much has been appreciated out and how much is still left to be depreciated. The balance sheet is used to calculate the book value of the business.
A balance sheet will be divided into two columns: First the assets, and then the liabilities and owner’s equity. Assets are always listed from your most liquid assets (such as cash on hand and cash in the bank) to the least liquid assets (such as receivables and inventory).
The liabilities will list items such as accounts payable, accounts receivable, short-term and long-term loans, customer deposits, salaries and wages, sales taxes, insurance payables, payroll taxes. If you have retirement funds or a 401K, those would also be listed in your liabilities.
Edwards says the goal is to determine the “working capital” of your business. The working capital is the difference between your current cash in the bank and current receivables and payables within the next 30 days. To find your net working capital, subtract your assets from your liabilities.
“That’s how much money you’ve got to work with,” Edwards says.
Sachire recommends balancing and “scrubbing” the balance sheet on a monthly basis.
“Most shop owners don’t scrub their balance sheet,” she says. “In other words, they have things that shouldn’t be on there or are miscategorized. Scrub it with a brush: Make sure everything on there should be there and is right. If things don’t balance or tie up, that tells me there are bigger problems.”
Document #3: Income Statement
The income statement is a report that details your shop’s sales, costs and overhead expenses for a period of time and the gross and net profits that resulted from those activities. The statement reflects how your shop is performing from a financial perspective in specific areas of the business.
To begin, the income statement lists the sales, cost of sales and gross profits of the following categories: Metal, frame, paint, paint and materials, sublet. Those totals float to the income and expense page of the statement, Edwards says, but this page will show your shop’s total sales and total gross profit. Edwards says the minimum benchmark is 52–54 percent gross profit.
“If your gross profit is below that number, you want to go back up to each category and compare your gross profit margins by category,” he says. “That will help you narrow it down and drill into the problem.”
At this point, Edwards says you should compare your total sales and gross profit to three factors:
1.) Your trends over time. How are you doing this year versus last year? Edwards recommends a goal of a 10 percent annual growth rate.
2.) Other shops of like size. Edwards says the easiest way to do this is by being involved in a 20 Group that shares financial numbers.
3.) Industry guidelines for those key areas. Edwards says you can obtain those industry benchmarks from consultants, paint companies or management groups.
The second page of the income statement is referred to as the “income and expense page.”
The totals from the first page will make up the income section, and Edwards recommends the expenses be broken down into three sections:
First is personnel expenses (salaries and wages of all of your staff, including your own salary, and additional staff costs, like health care, uniforms or other benefits); then semi-fixed expenses (usage-based expenses, such as advertising, computer IT support or policy adjustment, which occur every month but vary in price); and finally, fixed expenses (expenses that occur every month at the same rate, such as rent, amortization and leaseholds).
From the top down, the page will list sales and gross profit, expenses by category, total expenses, and net profit. Edwards says to shoot for 20 percent net profit.
He recommends following this over time and comparing the same three factors.