It's that time of year. Here's how to get started taking out the trash:
1. Separate accounts receivable from accounts deceivable.
Keeping a puffed up AR is kind of like sporting "the emperor's new suit:" You think you're covered but you're not. In reality, you're hanging out there, exposing yourself to useless forecasts.
If you can't or don't want to write off potentially uncollectable accounts, create a sub-account for "doubtful accounts." Do not include them in cash projections, but continue collection efforts and enjoy the windfall if and when you get paid.
Worse than not making a sale is not getting paid for the sales you make. Take the time to analyze your doubtful accounts. Look for internal factors that may have contributed. Try to identify the patterns. We can't control all the bad things that come our way but we can control the bad things we create. Were the losses a result of poor credit decisions, inadequate collection practices, or faulty execution such as billing errors or customer dissatisfaction? What improvements can you make to your credit and collection policies?
2. Pare down your payables. We will bet you a nickle (an IOU is fine), that you have accounts that you don't owe, have already paid, or don't need to pay. Procedures to identify these "non-payables" will largely depend on the complexity of the business and the sophistication of the financial systems. It can be as involved as hiring outside auditors, or as simple as running a sniff test (anything that doesn't smell right warrants investigation).
Here's a simple process that will work for most companies:
- Step 1: Sort payables by your oldest bills and/or your largest vendors.
- Step 2: Check your checks for any bills that might have been paid but not posted properly.
- Step 3: Request current vendor statements or histories for reconciliation. Delete bills that you don't owe, add any bills that you do, and create a 'doubtful payable' subcategory or class designation for those you're not sure of.
- Step 4: Review your vendor agreements to confirm that you are being billed only for that which you've agreed to.
3. Balance your balance sheet. For managerial purposes, your balance sheet should be boiled down to this formula: Subtract what you owe from what you own and that equals what you can keep. In financial circles, this is called equity.
Assets are what you own. Cash or things that can ultimately be converted into cash, such as inventory, receivables, real estate, equipment, and patents are assets. If that conversion is likely to occur within the next year, it is a current asset. Beyond a year, it's a long-term asset. Anything else -- get it off your balance sheet. That being said, there are other line items on the balance sheet that are there and need to remain for minor things such as preparing annual reports and tax returns. Don't mess with those. Your accountant would kill you.
Liabilities are what you owe. If you have to pay it within the year, it's a current liability. If you have to pay it next year or beyond, it's a long-term liability. If you don't have to pay it at all, well, it's not really a liability, is it?
Owner's Equity is the difference between the two. This is the ultimate key performance indicator. It's the number to pay attention to, monitor, manage, coax, control, protect, and nurture. This is your leverage, your ticket to ride. Whatever your goal is -- borrowing money for expansion, attracting investors, or planning a big bang exit strategy -- the stronger the balance sheet, the easier, bigger and better the pay-out.
4. Polish your P&Ls. Start by putting your Income Statement (Profit and Loss) through the transparency test. Are you able to clearly see gross profit by profit center? In order to make more money, you need to know where you are making it and where you are losing it. This can be product, service, market segment, location, distribution, or whatever your material value drivers are.
If you have the transparency, congratulations. Now, the challenge is to maintain it. Your annual P&L check up should include verification that your profit center segregation is still relevant and that the direct expenses are being properly matched.
Next, identify spending targets: Nobody wakes up one day to find him or herself having gained two hundred pounds or acquired $2 million in debt. It happens a pound and a dollar at a time. The only way to counter "expense creep" is to set targets and ranges. We like to see them displayed similarly to the way blood work is displayed from the lab: It's bolded and highlighted if it's outside of range. Sometimes, there are reasons for it. Other times, it's a red flag that needs investigation and/or intervention.
Finally, create a re-bid calendar. For each ongoing or recurring cost, schedule a date for when it is to be shopped or re-bid. We routinely do this for things like insurance premiums. However, implementing this as a system and expanding it to include all expense items, can save thousands of dollars. All of which will go directly to your bottom line.
Have a small business finance question for The Money Dept.? Hit the comments or email Rich and Mary using the contact form under their photo.
Flickr photo courtesy of newlivinghouston, CC 2.0