In this issue we finish the series with dispelling Myth #3.
Myth #3: My financials indicate I made (or lost) money, but I don’t believe it.
Not many people say this out loud, but I wish they would, so we can help them better understand their situation. Understanding the difference between one’s perception of business performance and financial reality can be the first step into true insight, which will lead to better decision-making.
First, your financials are based upon certain assumptions or accounting policies, which may be minor in some businesses but huge in others. These may include depreciation calculations, amortization, bad debt recognition, revenue recognition, tax provision computations, etc. A business owner needs to understand how these policies affect profits and losses. Keep in mind that the sole rationale underlying the rules of reporting is to accurately reflect the financial condition of the company. Rather that dismiss them as arbitrary, you can use them productively to discuss your financials – with your banker, for instance.
Second, it’s important to understand that profits don’t always feel like profits. Profitable businesses can and often do have negative cash flows. Uncollected receivables or inflated inventories, for example, are drains on cash but not profits. Conversely, delaying payments to suppliers keeps cash in the bank, but it simply leads to angry vendors, not higher profits. Hence, one needs to understand the cash flow statement as well as the income statement. From there you can build appropriate plans to ensure the financial stability of your business.
Finally, it’s important for you to ask questions about your financial statements and how they impact your business. If you don’t understand the answer, ask again, and persist until you sort out where your perceptions collide with financial reality. This knowledge gives you a true realization of the issues facing your business so that you can fix them sooner rather than later.