Quarterly Checkup: Your Q1 Results Set the Trend for the Year
If your business is on a calendar year, you've finished your first-quarter operations. Hopefully, your accountant or bookkeeper gave you your financial reports by April 15--both an income statement and a balance sheet--and you spent time reviewing them.
So, how did you do???
If you set up your financial information for maximum "management intelligence," you now have a very accurate picture of how your business is performing. Your financial statement should have given you your 2016 first-quarter results compared with your 2015 first-quarter results, and also compared your results with your annual plan for the first quarter of 2016.
Let's talk trends
- Revenue. Up or down? Compared with last year, are you ahead? If so, did you meet your plan? If not, what happened, and how are you going to fix it? Remember: "Financial data is absolutely worthless unless it drives operational improvement."
- Cost of goods sold (COGS). Up or down? If your revenue is up, has your COGS increased faster, eroding your gross margin? In one of my previous articles I gave you an assignment to find a 2 percent improvement (by that I mean a reduction!) in your COGS this year. So, at the end of first quarter is your COGS down a full 2 percent from where you were last year? If not, why not, and what are you going to do to fix it?
- Gross margin. Increasing revenue and decreasing COGS drives up gross margin. However, many businesses find themselves in the exact opposite predicament (decreasing revenues and increasing COGS), which dramatically erodes gross margin. Where are you? Remember, small percentage points really add up over the course of a year. If your gross margin is down a full 1 percent in first quarter 2016 over first quarter 2015, there should be huge alarm bells ringing in your head. Go find it, and don't let it go! If this continues over the course of a full year at an annual sales volume of $1 million, you could have eroded $40,000 of gross margin by year-end. This is totally unacceptable!
- G&A expense. (This means everything below the gross margin line.) Your other assignment was to find a 2 percent improvement in all of these costs. Did you achieve it? If not, what are you going to do about it? The only way you're going to get a cost down in your business is to drive it, beat it, whack it, and punch it down. None of your vendors is going to come to you and say, "Oh by the way Bob, we're giving you a 2 percent price decrease this year because you're such a great customer!"
- Owner's discretionary profit (ODP): That's everything you take out of the business for yourself. Up or down? Usually when a business's operating profit is down, so is the chunk you get to keep. Your goal this year was to improve what you paid yourself a full 5 percent of your gross revenues. "Are you there yet?"
Now let's take a look at your balance sheet--at two critically important ratios: your current ratio and your debt-to-worth ratio.
- Current ratio. Remember, this is calculated by dividing all your current assets (everything coming in and converting to cash this year) by all your current liabilities (everything you have to pay out in cash this year). This measures your ability to pay your bills. The bank is looking for a 2:1 current ratio, meaning that for every dollar you have going out on the bottom of the ratio, you have two dollars coming in on the top. How do you measure up? Is your current ratio up or down from last year? If it's down, why, and what are you going to do to fix it?
- Debt-to-worth ratio. This measures that all-important four-letter word every banker hates and every business owner should carefully understand about their business: risk. Is your risk up or down this year? To calculate your debt-to-worth ratio, divide your total liabilities by your net worth. This will give you a very clear measurement of how much more or less risky your business has become at whatever your sales level is at the end of first quarter.
For every dollar of net worth on the bottom, you have X dollars of debt on the top. In a recent benchmark study we just completed, the range was from 3:1 to 5:1. Let's put that into words: in the worst-performing operations, for every dollar the business owner owned they owed three dollars in debt. In the best-performing operations, for every dollar the business owners owned they only owed 50 cents in debt. Yes, you can have a bigger, weaker company. If you do, you need to fix it, now.
Your first quarter results are critically important and set the trend for your financial performance for the rest of the year. Don't ignore them! Find out what's happening inside your business and, if necessary, fix it. No one is going to do it for you.
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