Editor's Note: This is the first of two "Scoring in Business" columns submitted by Bill O'Brien which will examine techniques for measuring financial performance.
Question: What are the first things that always happen at a doctor's office visit (that is, after they make sure you're insured)? The nurse measures your blood pressure, weight and pulse.
Question: What do diabetics do daily? They measure their blood sugar level.
One can't manage one's health if one doesn't first measure relevant vital signs to see what's going on and what remedial action/management steps are required, if any, to maintain or restore good health.
The same "measure to manage" process is used in every Standard and Poor's 500 company; the National Football League (yards per carry and completion percentages, etc.); Major League Baseball (RBIs/ERAs, etc.); well-run educational institutions (ACT/SAT scores); the NBA; NHL, etc.. Why then do so many otherwise intelligent small business owners and individuals pay so little attention to measuring and managing their financial affairs? Let's see if we can make some sense of this puzzling and potentially ruinous situation.
Let's first define the meaning of manage. Webster's dictionary says "manage" means "to succeed in accomplishing; to achieve one's purpose." Of course, we all want to "succeed", or to "achieve", but a shockingly large number of people are not willing to do what it takes to improve their chances of doing this.
Twenty years of SCORE consulting in our area clearly support the evidence for the above statement. A depressingly large number of our clients show little or no awareness of the need for the simple techniques used to measure and manage the financial performance of both their business and their family affairs. The following techniques would allow them to quickly identify and exploit opportunities or to promptly correct problems. Without them, many clients fail or simply stumble along. How many? The following facts, based on U.S. Department of Commerce and U.S. Department of Labor business statistics, illustrate the fragile and dangerous environment in which small businesses operate and why they must use every proven weapon possible to survive:
-- approximately 30 percent of new businesses, with more than one employee, fail in the first two years;
-- approximately 50 percent of new businesses, with more than one employee, fail in the first five years;
-- approximately 60 percent of new businesses, with more than one employee, fail in the first 10 years;
-- only 20-30 percent of new businesses survive long-term; and,
-- only 5 pecent thrive.
There are various reasons for such dismal results, but experience identifies a primary cause. Small businesses and families are either unaware of the critical importance of measuring the performance of their business and/or family finances or they feel threatened by the perceived technical skills required to do so and use rationales such as "too boring" to explain their neglect.
Such ignorance, fears, and rationalizations are totally unnecessary. The tools required to measure one's business and personal financial affairs are nothing more than addition and subtraction. The measurement tools I am talking about are called profit and loss (P&L ) statements for businesses and cash flow (C/F), budget/projections for both businesses and households. I am mathematically challenged but even I understand these tools. Quantum Mechanics they are not.
This week, we will discuss one of the two essential tools of measuring and managing your business: profit and loss (P&L) statements.
This type of statement is nothing more than a listing, and then totaling, of all of a business' sources and amounts of income (sales, interest, etc.). After this, a listing and totaling of all the business' sources and amounts of expenses needs to be made. The resulting difference between these two (income and expense totals) represents the firm's profit or loss over a specific time frame (i.e., a day. week, month, quarter or year). A profit and loss statement is simply keeping score.
Thus, the statement measures your profit or loss for a specific time period. The profit or loss (plus or minus figure) indicates the degree of financial success or failure for the period measured. Thereafter, it is simply history -- important and useful as a trend indicator, but generally not used in future financial calculations.
The next column in this series will lay out, in simple, understandable terms, the steps to follow to prepare the second essential and uncomplicated financial measurement/management tool: cash flow. It is key to maintaining your business and family financial health. To be continued....
See SCORE to learn more about these critical financial management practices. Our consultations are free and confidential.
Bill O'Brien has a background as an advertising executive and is a volunteer business counselor with SCORE's Tip of the Mitt chapter. The "Scoring in Business" columns provided by SCORE counselors appear the second and fourth Wednesdays of each month on the Business page. The SCORE chapter can be e-mailed at email@example.com. Mail can be sent in care of the Petoskey Regional Chamber of Commerce, 401 E. Mitchell St., Petoskey, Mich. 49770.