Be an Ethical Entrepreneur, Marketer, and Business Builder

How to create General Ledger codes for your small business’ Profit & Loss statement

Creating income and expense codes to setup a useful P&L for your business sounds about as exciting as sweeping the floors in your shop… Better left to your accountant, right? Wrong! Unless your accountant is quite business-savvy that’s a mistake because accountants aren’t necessarily trained in business… They’re trained in accounting… And there’s a big difference between the 2.

If your accountant did setup your GL codes now’s a good time to review them to see if they’re providing you valuable information at a glance. Here are a few quick rules to setup a useful, valuable Profit & Loss statement that will actually provide you with the information you need to make important business decisions. First of all, let’s lay out the goal for your P&L. The goal of a small business P&L is to quickly show you which departments (or revenue streams) in your business are making money and which are not. The secondary goal, for when you go to sell your business, is to provide you with a cashflow value of the business utilizing EBIDTA or Seller’s Discretionary Earnings. The third use of your P&L is of course taxes. For this article, let’s focus on your month-to-month use of a profit and loss statement, not just it’s utility at the time of sale or for paying your tax bill.

  1. Income and expense codes should be departmentalized. – This is crucial because it’s the only way for us to tell where the money is coming from and where the money is going. As an example if you own a powersports dealership, you should have separate income codes for motorcycle sales, ATV sales, jet-ski sales, dirt-bike sales, motorcycle parts, ATV parts, jet-ski parts, dirt-bike parts, and service. Breaking out service according to each isn’t really necessary since your labor costs are generally the same regardless of whether you’re working on a jet-ski or motorcycle. Though it’s not necessary on your P&L, you should also be able to tell which type of bikes are selling best and with the best margins and which are not (i.e. cruisers vs sport-bikes, Harley vs Can-am).
  2. Income codes should have a matching expense code. – From the example above each of those income codes should have a corresponding expense code such as Cost – Motorcycles, Cost – ATV’s, Cost – motorcycle parts and so on. Why? Because that’s what tells us quickly if each of our items are priced at a profit (or not). This is actually a rather common problem in small businesses. Costs go up over time and owner’s don’t increase sale prices to match because they aren’t ordering or reviewing each statement so they just don’t notice. When your P&L does that work for you, it’s easy every month to review and catch any drastic changes in margins. Granted, to really keep on top of your margins for everything you sell, a detailed parts and equipment list that is CONSTANTLY updated is vital.
  3. Cost of Goods Sold codes should only be codes that are affected by fluctuations in sales.– This is just a rule of thumb for determining if an expense should be COGS or an Operating Expense. If sales going up or down doesn’t change the expense  in question, it should be considered an Operating Expense.
  4. Wages should be departmentalized (and segregated between COGS and Operating Expenses). – Sales commissions and service department wages are a Cost of Goods Sold.  Office staff, accounting, customer service, and managers (outside of sales and service managers) are an overhead and should go in your Operating Expenses along with the corresponding payroll taxes and benefits.
  5. Insurance should be broken-down. – By this I simply mean just because you get a single bill from your commercial service provider for General Liability, Vehicles, Buildings, and Inventory you shouldn’t just put in a single line-item on your P&L for Insurance. Each of those items should be listed individually under your Operating Expenses.
  6. Royalties are a COGS. – In most franchises royalties are levied as a percentage of revenue and should be listed as a Cost of Goods Sold, not an Operating Expense. Additionally, royalties should be considered a marketing expense since, in exchange for paying those royalties, you get to use your franchiser’s name and the goodwill and value they’ve invested in that name.

That’s it. Making an effective P&L for your business can be done in an afternoon and once setup in your billing and accounting software should easily provide you with the vital information you need for years with very little ongoing maintenance. Take the time to update your P&L and start making better business decisions today.

To your accounting success, Bryan

How to fix your business FAST – Part 2 – Know your numbers!

The world lives and dies by numbers. Granted I am an engineer by education so I may be a little bias…

Even more importantly, the world gets answers to questions by the correct numbers. If you’re looking at the wrong numbers, you’re never getting answers to your questions. Let me give you a quick analogy. In the world of internal combustion engine building we’re all looking for a few major numbers – namely horsepower and torque. So we hook an engine up to a dynamometer (a device that measures the power output of an engine) and now we know the horsepower and torque numbers. So what? How do I improve those? Well to do that you have to look at a lot of other numbers such as bore and stroke, number of cylinders, 2 or 4-strokes per cycle, manifold pressure, air-to-fuel ratios, cam lift and duration, ignition timing… And the list goes on and on and on… Without knowing how that engine is currently configured, I can’t possibly tell you what to “fix” to help it make more power.

Your business has 3 “big” numbers, they are # of customers, revenue and profit.  Those are your horsepower and torque. All they tell you is where you’re at right at this moment. They don’t tell me how we got there or how we’re going to make more power (profit) the next time around. Even if you don’t know a single thing about engines, I’m hoping that analogy makes sense. The bottom line is, you have to know your numbers and they have to be the CORRECT numbers.

Let’s break your numbers down into a few basic categories (you’ll notice these are the same as I reference when talking about the 3 leaders every business needs):

  1. Finance/Accounting
  2. Sales/Marketing
  3. Service/Operations

Finance/Accounting – These are the numbers you get from your bookkeeper.

  1. Profit & Loss
  2. Balance Sheet
  3. Current Receivables (along with the aging)
  4. Current Payables (along with the aging)
  5. Cash in the bank

These are the numbers that provide questions, but no answers. Your bookkeeper only knows enough to start asking a few questions. Things like,

  • “I see you spent $40,000 last year on marketing, what was your return on that?”
  • “Your cell phone bills average $115/person, have you shopped around for a cheaper plan?”
  • “You have $6,000/year in Meals & Entertainment, is that necessary or can that be cut back?”
  • “It appears that sales are down 20% but costs are only down 10%, why is that?”
  • “15% of your receivables are more than 60 days past due, what are you doing to collect money?”

As you can see, none of the reports under Finance/Accounting provide any answers except maybe to the question, “Do we have enough money to cover next payroll?” That doesn’t mean we don’t look at these numbers because this is where we measure the results. If we add a turbocharger to an engine, ultimately we want to see that reflected in higher horsepower and torque. The same is true for your business.

To start answering the questions about why your business has less customers, less revenues, and less profits, you need to use Brad Sugar’s business chassis. Buy his book Instant Cashflow, learn the chassis, and use it. You can also learn about the business chassis on Brad’s blog.

Sales/Marketing – Now we’re getting into the fun stuff. Here’s a quick list of the numbers you should know in this realm:

  1. Number of New Leads (daily or weekly, though some establishments will even look at this by the hour of day)
  2. Conversion Rate (i.e. the % of leads who become customers)
  3. Number of New Customers (how many people have bought from you?)
  4. Average Dollar Sale (revenue/total # of transactions)
  5. Average # of Times a Customer Purchases from you Each Year (total # of transactions/total number of customers)
  6. Cost per Lead (for each marketing project)
  7. Cost per Sale (for each marketing project)

Do you see where we’re going with this? If our sales are down, now I can pinpoint if it’s because we’re getting less leads, converting less leads to customers, selling a lower dollar amount per transaction, and/or because our customers aren’t coming back as often. Now we’re getting somewhere! With these numbers you’ll even be able to pinpoint that you’re getting less leads because that radio ad you started 6 months ago is no longer making the phone ring. In the next few blogs, when I get to the step about Improving Marketing and Sales, we’ll look at specific ways to improve each of the numbers above.

Service/Operations – This is your back-end. Once you’ve sold a product, this is how you deliver it, service it, restock inventory, order more inventory, schedule service, and everything else that’s in essence “behind the scenes”. The important numbers for Service/Operations can vary quite a bit from industry to industry however the concepts are the same so make the proper adjustments for your industry.

  1. Profit per income generating person – this could be per plumber, electrician, waitress, sales associate, barista or anything else. If a person on your team has the ability to generate income, you need to know this number.
  2. Income per income generating person – this is important because often these individuals have more control over the income they generate than the costs they incur. That doesn’t mean their choices don’t affect the costs of the business, I’m just saying that a plumber can’t much affect the cost of gas or the distance to his job or the markup for parts or the hourly rate.
  3. Turn-over – how long does it take between buying something for inventory and selling it. Car dealerships look at “average days on lot”, retail stores look at “average day on shelves”, service-based businesses might look at “number of days from inquiry to finished service.”
  4. Profit-margins – In other words, the mark-up of each product or service. If you’re a service-based business you need to determine the cost/hour for your billable people to determine your profit-margins.
  5. Customer Complaints – You might be surprised how close your customer complaints as a % of customers served mimics your net profits.
  6. Uncompleted Work – For retail or restaurant style businesses you don’t really have an equivalent for this. People walk into your business, they buy something, you provide it immediately, and your work is done. For service-based businesses, however, this information is crucial. If work isn’t getting done, or you’re getting behind, or customers aren’t being notified of delays, you’re going to have problems. You need to know how many outstanding work orders, quotes, and return phone calls are out there so they don’t ever slip through the cracks.
  7. Free Work – This means you screwed up an order and gave someone a free meal, or a free hour of labor, or a free part, or a free legal consultation, or you had to go back to their home or business to fix a problem you didn’t fix the first time. You screwed up and had to make amends and the cheapest way to do so was to do it for free.
  8. Daily, Weekly, and Monthly Break-Even – In other words, do you know exactly how much you need to sell today, this week, and this month to break-even. Some businesses will even break this down to per shift if there are multiple shifts within a day.
  9. Lost Customers – Since my blogs have talked quite a bit about recurring revenue, you need to have a very close watch over your recurring revenue customers. If one of them calls to cancel services, you better have someone trained to try and save that account. This is almost impossible to track if you have a retail style business.

Those are your numbers. Obviously there can be more, however those are the most universal and the ones I’d look at for just about every business from a law firm to a candy store to a hospital.

To your “number-knowing” success, Bryan

P.S. If you’re wondering how you track all of these numbers, the simple answer is with industry-specific software. If you don’t have any, make it a priority to purchase or lease some right away.

A few more ways to get tax-free money from your business…

As I’ve pointed out before, when dealing with customers, team members, suppliers and even the tax man I’m not at all a fan of doing anything “under-the-table” or unethical. So keeping that in mind, here are a few ways to get tax free money from your business.

  1. Credit Card Rebates – This would be the ever popular cashback, rewards, points, and travel credit cards. The IRS currently has no provisions for rebates of any kind so this can easily add hundreds (if not thousands) of dollars in cash, gifts, or travel expenses into your pocket tax-free. I personally have 3 rebate cards. One from American Express, one CapitalOne visa, and a Discover card. The rebates range from 1-5% and in about 8 months of random purchases (both personal and corporate) I accumulated over $500 in rebates. My personal preference is to receive cash rebates so I can spend the money wherever I want however I’m looking into travel rebates since I tend to travel a lot.
  2. Purchase Rebates – These are the rebates you find at large retailers where you buy a fax machine and can receive a $50 mail-in-rebate. Guess what? The total expense is deductible and when the rebate comes in the money is yours. Check with your accountant (cause I’m definitely not one).
  3. Marketing – This is one of my favorites. A few weeks ago I sat down with my accountant and asked about my business sponsoring a race car at the local track. Turns out it’s 100% deductible. The racecar (or motorcycle), repairs, gas to get there, parts, etc. etc. can all be written-off as marketing expenses. If you are always racing something like me, then you really shouldn’t let this tax-free racing budget pass you by. Of course your race vehicle needs to advertise your business.
  4. Personal Development/Training – My accountant just educated me on this one recently. Currently I have 2 businesses that are about 4 hours apart with a total territory that would take me about 12 hours to circle by driving. Add to that the possibility of another business about 4 hours away in a different direction and the benefits of flying become quite obvious. So I’m working on getting my personal pilot’s license so I can fly myself around for business and also a bit just for fun. Just like with a company car, you need to figure out how much of your time is truly business and how much is personal and allocate the proper amount of your flight instruction and flying lessons through your business. Of course that would be a direct, pre-tax, business expense.
  5. Gifts – Not sure if this varies by state or is just for federal however my accountant informed me that a performance based incentive of up to $400 can be awarded to all employees without claiming it as taxable income each year. This can be in the form of a gift or simply cash. Hopefully you’ve performed well enough in your business to earn such an award. 🙂

It seems like I’m learning new, creative, legitimate ways to benefit from owning a business on a weekly basis so as I learn more I’ll post them. If you have any great ways to lessen your tax burden legally please let me know!

To your success, Bryan

P.S. I’m not an accountant and everyone’s situation is different, so make sure you check with your accountant before starting any of this. 🙂

Profits vs. Cashflow – Do you really know the difference?

In my office I have 2 young, inexperienced girls who help me. They both have wonderful personalities and great phone voices and, though they’re not perfect, they seem passionate about their jobs and eager to learn. One girl’s responsibility is to help me grow the business, the other is to help me cut expenses… At this point I’m still trying to determine if I’m better off employing people who I can train from the ground up, as The E-Myth Revisited suggests, or if I should hire the best people and pay accordingly, as many business owners suggest.

However cutting expenses isn’t as “straight-forward” as one would expect. If you had to explain and train a 19 year old with no experience on how to manage the payables, purchasing, inventory and cashflow for a business employing 13 people what would you teach them? How would you teach it?

These are the questions she needs to consider every day:

  1. How can we improve Profits?
  2. How can we improve Cashflow?

So let’s explain the difference between profits and cashflow first.

  1. Profits – Profits are an income statement or financial and tax reporting number. They don’t have a direct influence on if you can pay your bills or when. This number simply tells us if you sold more then you spent.
  2. Cashflow – This is money or cash you have available to spend. In other words, cash in the bank.

A quick example to illustrate the stark difference between profits and cashflow and why both need to be addressed is this: If I can order 100 widgets at a 10% discount and I ultimately sell all 100 widgets, then I just increased my profits 10% by cutting expenses. However if I order 100 widgets at a 10% discount and it takes me a year to sell them so I didn’t have the cash to pay the bill right away, the late charges and finance charges may out weigh the 10% discount. Or let’s say they only gave us a 3% discount, I could have put that money in a money market fund for the next year at a higher interest rate then 3% and been better off.

OK, so how do we systematize and simplify this concept? We created a spreadsheet listing all of our vendors along with the following columns with information: Vendor, Terms, Discount Terms (i.e if it’s due in 30 days but we pay the bill in 10 will we get a discount?), Late Fees, Finance Charges, Grace Period, Finance Policy.

That simple spreadsheet tells her, me, the person who replaces her if she quits, my business partner or anyone else who looks at it exactly who we need to pay and when. In other words, if cash is tight, we simply reference the spreadsheet to determine which bill we pay first and which ones we can pay late and with the “Finance Policy” we can even estimate who may credit off finance charges if we call and negotiate.

The “Terms” tell us about our cashflow options and the “Late fees”, “Finance Charges” and “Discount Terms” let us know how the vendors’ policies will affect our profits. It’s simple and straightforward, however it does take some work to collect all of this information from all of your vendors.

Keep in mind, your vendor may tell you something that experience tells you is not true. For instance, MOST billing systems where you are sent an invoice have a set term in days, however they don’t actually apply late charges until the end of the month. So you may receive an invoice on 10/25 that says Net 15. The invoice says it’s due 11/9 and that late invoices will accrue a finance charge of 1.5% per month. If you call and ask the vendor, they’ll tell you it’s due 11/9. However what that generally means is as long as you pay the bill before that company “closes their billing month” (which could vary from the 25th to the 31st of the month) you won’t be assessed any finance charges. In essence that mean the bill isn’t due until the end of the month. 🙂  In our spreadsheet we know which customers to pay exactly on the due date and which to pay before the end of the month because of the “Grace Period” field.

With QuickBooks Pro 2009
this process becomes even easier. You can setup custom terms along with applicable discounts so that when you put in the bill, Quickbooks automatically knows, and applies, your “Early Payment” discounts for the vendors who offer them. This is possible whether you receive discounts by paying exactly within 10 days from invoice date or if you just have to pay before the 10th day after the month-end in which you recieved the invoice. The custom terms in Quickbooks is quite powerful. It’s main limitation, and the reason for the spreadsheet, is you need to know the “Grace Period”, if any, as well as the “Late Charges”, “Finance Charges” and “Financial Policy”. You could probably put that information in the notes field on the vendor’s account but quickly referencing the spreadsheet seems to be easier.

In addition to the information and concepts I need to teach to my impressionable payables person, there are a few concepts that just my accountant and I need to understand. Those are the expenses I must depreciate and the goodwill I can amortize. Depreciation can either help with profits and hurt cashflow or hurt profits and help with cashflow. First off, helping or hurting your profits depends on whether you’re talking with your banker or the tax man. If you’re talking with your banker you obviously want to show lots of profit however with the tax man you want to show very little. Granted, we need to be honest, upfront, and ethical with both if we want the best for ourselves and business. Your banker will often look at EBITDA so that your non-cash expenses won’t hurt the “profits” they consider, but they’ll also look at your cashflow statement. Depreciation is usually a negative against your cashflow initially and a positive near the end of a product’s depreciable life. For instance, you may depreciate a computer over a number of years, however you need to pay for it all upfront. Since you have to pay for it immediately your cashflow is hurt. Yet, it’s now paid for so in a year the bills are all paid, but you can still take the depreciation expense on your books to minimize your profits and which helps minimize your tax burden. As a general rule, you expense everything immediately and forget about depreciation! Why? Because taking the immediate expense will help your cashflow by decreasing the taxes you’ll have to pay on your profit. There are exceptions…

Without going into a lengthy explanation of amortization, the rules are relatively the same as depreciation. The primary difference being that amortization NEVER effects cashflow. Amortization is simply an accounting number that has no bearing on your actual cash investment. I know accountants will disagree with me on this because they say it represents the difference between what you’ve bought something for and what it’s worth so your amortization deduction is equal to the cash you paid out of pocket. This is only true if you used your own money to buy the business. But why would you do that when 65% of businesses are sold with some sort of vendor financing?

For some more specific ideas on the ways your payables person should be improving cashflow check out my other blog.

To your success, Bryan

If you’d like a copy of the spreadsheet email or comment.