Four Steps To Improve Business Financial Health

Four Steps You Can Take Today That Will Improve Your Business’s Financial Health Tomorrow.

How do you know if your business is financially fit? Well…

• It’s not what the Jones tell you.
• It’s not how well your business stacks-up against its competition. Although you can use industry metrics to improve financial health.
• It’s not how much the bank is willing loan to you. Although issued and outstanding credit is significantly less expensive for a financially fit business.

If it’s not these… Then what is it?

Ask yourself these questions:

• Is your business paying you appropriately for the work you do as the owner?
• Does your business pay enough in dividends to fund your retirement? Your spouse’s retirement? Your family’s vacation fund? Your family’s other saving funds?
• Does your business have enough cash on-hand to pay six-months in operating expenses should all income suddenly stop?
• Do current asset balances double current liability balances?
• Do long-term asset values exceed long-term debt balances?
• Is the business’s overall value high enough to pay 10x your annual wage should you sell it today? Is it enough to retire? Or take a three-year vacation before starting another business?

If you answered ‘Yes’ to all of these questions, and you’re confident there’s no way any one of them can improve, then you have a financially fit business!

However, if you answered ‘No’ to at least one of the questions, or you believe at least one can improve, then there’s opportunity to improve your business’s financial health.

Here are four steps you can take today to improve your business’s financial health tomorrow! This is an interactive blog with tables to help you complete them on your own. Feel free to print the blog and fill-in the boxes as you read through the material. Assuming you have organized financial records, you can complete all four steps within the hour. If you want a tool to make it easier on you, then click HERE to download your Needs Assessment Workpaper. 

1st Step. Define your financial needs

Below are the most-popular questions answered by owners when defining their financial needs. Of course, your needs are going to be unique to you.  Answer the questions below and consider adding your own to capture your needs on a monthly, quarterly, and yearly basis.

I highly suggest you contact your local financial planner. These professionals will help you look into your life’s crystal ball and tell you how much you need to make, how much you need to save, and how little you should spend today so you can afford your desires tomorrow. 

In the meantime, let’s walk thorough an exercise to get you started. For each row:

1. Write-in the amount you need on a monthly basis.
2. Multiply by 3 to get your quarterly needs.
3. Multiply by 12 to get your yearly needs.

Pro-Tip: You probably wear multiple hats in your business. If so, pick the one function you spend the most time doing and use Glassdoor to research salaries for that position. As the owner, you are most likely the only CEO in your business, so consider using CEO for your search. We also suggest you use a larger city in your area to capture more data and the ability to adjust for industry, business size, etc. If you are lazy and don’t want to do the research yourself, then we’ll save you the hassle and suggest you use $12,500/month, $37,500/quarter, and $150,000/year.

As an owner, you don’t get a 401k match, bonuses for a job well done, or other benefits you would otherwise receive as an employee. Your profits replaces these benefits. Also, you need to save for ‘oh-shit’ moments. At any point in time, it’s a good idea to have cash reserves that will cover six-months of operating expenses. The accumulation of these items, plus some, are your profit needs.

For some of the questions, you may not know how much to save this month. If this is the case, then do the exercise backwards. Write-out the total dollars you’ll need to make it happen in the future, the year you want it to come true, and divide the dollars by the number of years between now and then. Vwalah! You have your yearly saving needs!

Yes, I’m not joking. Take the sum of all items, multiply by 2, and put this amount in the bottom row. This is your monthly, quarterly, and annual profit needs. 

Is there more to consider for your needs? If so, write it out! You can also do a Google search to brainstorm potential needs. There is a ton of information online to help you envision your future. If you do use articles from the internet, check the source and evaluate if it is appropriate for you.

Whoot whoot! You just defined your financial needs as the owner of your business! How does it feel? Are needed wages and needed profits more or less than you originally expected?

2nd Step. Benchmark based on your needs

In Step 2, we’re going to calculate your business’s current financial health. We’re then going to use your annual needs from Step 1 and set benchmarks based on your needs. We’re finally going to put it all together and end with a plan to keep you on-track as you improve your business’s financial health.

Step 2 is going to require you do some digging into your business’s financial records. Ideally you have an accounting system, such as QuickBooks Online, to easily capture this stuff. If not, you’ll want to dig-up last year’s tax return. Assuming you did your tax return honestly, and correctly, it should help with this. Otherwise you’re going to need to bust out the bank statements, a pen, pad, and calculator to do this exercise. For your sake, and for many reasons beyond this exercise, I sure hope you maintain an up-to-date accounting software. If not let’s get you set up with one.

Use your business’s financial records and complete this exercise. Ideally, you would do this for the past 12 months. However, if you do not have an up-to-date accounting system, this may be a challenge and will take some time. Plan accordingly. If you do have an accounting system that is not up-to-date but was used to build last year’s tax return, then feel free to use the twelve-months activity supporting your return. Otherwise, if you do not have an accounting system at all, you have not filed a tax return in the last year or two, then have fun accumulating this information and call a tax attorney because you have much bigger problems…

Some of this might not make sense or you might not know where to look for each item. Don’t worry, you’re not alone. If this is the case, then feel free to call me. I’ve helped numerous owners do this over a phone call or a virtual meeting. I’ll happily do it for you too.

*Use the total of all business checking & saving account balances to calculate the change in cash. Subtract the total of all business checking & saving account balances at the beginning of the year from the total at the end of the year. If the number is positive, put that number in the cell. If the number is negative, put a ‘0’ in the cell.

Now, add up the amounts for each Benchmark Category and put them in the Total Current Annual Amounts column below. Then, calculate each row as a % of the Total Current Annual Sales Amount.

I’ve helped you calculate total annual sales as a % of total annual sales… You’re welcome!

**If your calculated Total Owner Pay amount is less than your needed owner pay identified in Step 1, then put the calculated Total Owner Pay amount in the cell.

**If the calculated Total Owner Pay amount is more than your needed owner pay identified in Step 1, then put the needed owner pay identified in Step 1 in the Total Owner Pay Annual Amounts cell and add any excess in with the Total Profit amount.  

Next, you’re going to calculate your needs as defined in Step 1 as a % of Total Sales. Use this table to help you.

***Go ahead and calculate 15% of the total annual sales and put it in the Total Tax Savings Needed cell. This is the amount you’ll need to set aside for taxes. Note, the #1 KPI of a good year is a high tax bill. The healthier your business gets, the more taxes you’re going to pay. It’s the nature of the beast. If you save the full 15%, then you should have enough to invest in tax-saving initiatives such as Health Saving Accounts, IRAs, college tuition plans, and other initiatives that will reduce your income taxes AND pay your tax bill. With these tax-saving initiatives, and a good tax accountant, you should have enough saved each year.  Regardless, I promise you’ll want to save the 15% of every sales dollar. When it comes to taxes, it’s better to have the savings and not need it than to need it and not have it!  

Now, let’s put it all together!

Plug the totals and calculated percentages in each respective cell below. You’ll notice another category called ‘Biz Ops.’ This is the money your business spent to operate during the year. Take annual sales for each column, subtract all other categories, and the remainder is Biz Ops. Calculate its % of total sales just like all other categories.

Don’t be surprised if the Biz Ops line doesn’t match your accounting system’s total reported expenses for the year. This is intentional. This calculation captures all expenses plus debt payments and any other uses of cash. 

To help you see a final product, I’ve created an example table below. We’re going to assume the example owner’s business sells $500k annually, she transferred $62k to her personal checking account during the year, and she did not make any estimated tax payments from the business. This business owner needs a $150k/year salary and needs $63k/year in profits.

Based on my example, the owner would need to cut expenses by over half to support her needs and have a financially healthy business. Sound like an unrealistic stretch? It’s not. These figures reflect most owners’ figures before they hire us. Later in the blog we’ll show you how this owner followed all four steps, adopting various other health-focused strategies appropriate for her business, and is now on-track to meet her needs.

How do your current and needed numbers look? Are there uncomfortably large differences like our example owner? Are you close? Are you doing better than your needs? Whatever your response, you might like to know what most ‘healthy’ businesses do in each of these categories.

Here are standard metrics for various businesses sizes, across multiple industries, across the globe.

Are you surprised by these? Do these metrics resemble your needed precentages? Or are these businesses doing better than your needs? The vast majority of business owners I know have needs in-line with these metrics. Even our example business owner! Crazy, huh?!

3rd Step. Make small and targeted changes

At this point we have defined your needs and set benchmarks to satisfy your needs. How the heck do we get it done?

Simple: small and targeted changes. There are two primary ways to improve your owner pay, profit savings, spending effectiveness, and overall financial health. They are:

1. Increase sales.
2. Decrease expenses.

Note, we don’t want to make super drastic changes all at once. Raising your rates a ton may cause customers to leave. Cutting expenses too quickly is essentially cutting the knees out from under your business. So how do I suggest you do it?

Increase sales – Unless you have a different growth strategy, make small and unnoticeable changes to your rates, year by year.  Increasing your rates by 5-10% every year is a good rule of thumb. Pro-Tip: Do some market research and find the top-dollar customers spend on your product or services in your competitive landscape and match it.

Does your growth strategy require to you be more aggressive? Or would you like to work less so you can spend more time with family? Let’s consider a different approach… Even if you raise rates by as much as 30%, causing you to lose 20% of your customers, the result is a 10% overall boost is sales AND you’re working 20% less. This is the equivalent of one full workday per week. You can apply that extra day to drumming up new business at your higher rates, or better yet, you can take Fridays off and spend it with your family. It’s a win-win!

Decrease expenses – Generally, it is easier (and less costly) to find savings in your current expenses than in is to drum up new sales. Don’t just take my word for it, hear it from our clients. Or this guy! Shoot to decrease expenses by 3% each quarter and buffer owner pay, profit savings, and tax savings by 1% each.

There are A TON of ways to go about decreasing your expenses. Here are a few of my favorite, and often fun, ways to cut expenses:

• Perform an expense review to find unnecessary spending. On average, whenever we do this with our clients, we’ll find $70k in savings! Almost always, the savings we find include unneeded subscriptions the owners didn’t even know they were paying!
• Open different bank accounts for each purpose (sales, owner pay, profit, tax, biz ops, etc.) and physically transfer money into each throughout the month. Doing so guarantees a boost to owner pay, profit and tax savings, and will decrease business spending.
• Limit the ways you can spend money. This can be done by cutting up all credit cards. You can also block schedule your week to pay all bills and make all purchases on one set day of the week.
• ‘Turn-off’ all spending during slow seasons. Pre-pay your fixed year-long expenses when cash is high and request a pre-payment discount from your vendors.
• I’ve also seen owners and employees brainstorm fun incentives such as a weekly ‘super-saver’ award and throwing a quarterly ‘profit party.’

What fun ideas can you come up with? Please share it with us so we can pass it along to others!

Pick one sales strategy and one expense saving strategy and implement them today. You don’t want to turn too many levers at once. So, go with ones you believe will have the biggest positive impact on your bottom line.

What do you think our example business owner did? I’ll tell you! Here’s what she did her first year.

• Day 1: Up until this year, she had busted her but on sales and was tired of it. She had no desire to increase business size and didn’t want to lose customers. Because of this, she went uber conservative and adopted the 5% rate increase.
• Day 1: She looked at her professional contracts, renegotiated with her marketing and advertising agencies, and with the money saved she invested in an accounting professional to help manage her finances.
• Month 1: With the accountant’s help, she did an expense review and found $70k in unnecessary spending which she removed immediately (mostly useless subscriptions and small purchases less than $100 totaling $5.8k per month).
• Month 2: She set-up different bank accounts and each quarter made 1% increases to owner pay, tax savings, and profit savings.
• Quarterly: She allocated that quarter’s portion of the $70k savings between owner pay and tax savings. The annual amounts totaled $60k and $10k, respectively.
• Daily: Aside from the $70k savings and renegotiated contracts, and since she didn’t take on any more growth, her remaining expenses supported sales or were fixed costs. She had to say ‘No’ to several other purchases during the year. It was hard to do but she was happy she did!

What do you think these initiatives amounted to? Do you suppose she hit any of her needed requirements?

4th Step. Monitor progress

We’ve defined your needs, set benchmarks to get you there, and implemented simple and targted strategies to improve financial health. It’s time to monitor your progress!

I suggest you take two hours at the end of every quarter and calculate that quarter’s figures. Compare these figures to your expectations and ask yourself:

• Did you meet or exceed expectations?
• If so, way to go! Why? Give yourself a big pat on the back and go celebrate.
• If you did not meet or exceed expectations, why? Look at your quarter in more detail… What happened? Did something cause sales to drop? Did you not implement your spending strategy as planned? Whatever the reason, figure out why, dust off your knees, fix the issue, and get back on the horse for another quarter.

As for our example business owner, this is what her business’s finances looked like as she monitored her first year.

Look at that! She almost met her owner pay and profit needs in her first year!

Bonus! Repeat

Repeat Steps 1 through 4 until you’ve made it! Celebrate and keep it up until you sell your business. Your needs are going to change, and believe me, the business isn’t going to always do what you want it to do. Keep mobile, keep your head up, continue trucking along, and stay focused.

It is also a good idea to have someone, outside of your business, watch over your shoulder. This is especially important if you are the owner/operator of a seasnal business. If this is you, my guess is you bust your butt making things happen during the peak months of the year. It is these months you DO NOT want your finances to slip. Even the slightest slip duing busy seaon is often a very costly mistake and will blow your whole year’s financial needs out of the water. My guess is you don’t have the capacity to oversee opeations AND effectively monitor finances during these imperative months. If you run in seasonal waves, and you want to protect your business’s financial health, which you’ve worked so hard to build, then let us help you. Our accounting services have been built with you in mind.

Let’s revisit our example business owner. How long do you think she took to meet her owner pay and profit saving needs? Let’s take a look! Below is a hybrid of what happened and what she expects in the future.

Since year 1:

• She’s now cut up all her company’s credit cards and set-up initiative specific bank accounts to manage spending.
• She meets with her accounting professional regularly to discuss business, review finances, and brainstorm small and targeted strategies based on her personal goals and what’s happening with her business.
• The owner continues to increase her sales rates by 5% each year.
• To not put a bind on her business, she allocates an additional 1% of each quarter’s sales to owner pay, tax, and profit. Note, a 1% increase each quarter amounts to an average 2% increase year-by-year.
• She did expense reviews every six months and now has her team involved. Because she has her team monitoring and reviewing their purchases, they are ‘bought-in’ to running a financially healthy business and are motivated to keep things financially healthy.
• For the first few years, she found more unnecessary spending in the items she previously thought were necessary. She purged these items immediately.
• Once she hit her owner’s pay need, she ‘snow-balled’ that 1% into tax and then into profit.
• Since she allocated more money to the owner pay, profit, and tax accounts, the biz ops account received fewer allocations each quarter. This held her and her team accountable to minimize expenses year-by-year. Plus, by now her expenses are relatively fixed so it’s easy to plan.
• Moving forward, she plans to delegate more responsibilities to her manager. Giving her the freedom to spend more time with family. She expects to pay the manager a bonus each year to keep him involved, excited, and “bought-in” to running a financially healthy business.

Check out the data:

She hit her owner pay requirement in year 3 and will hit her profit requirement and 15% tax requirement in year 6. Not to mention, at the end of the 6 years, she’ll have paid herself a combined $1,174,554 in owner pay and profits!

Had our owner not taken control of her finances, and adopted these strategies, she would have paid herself only $62,000 each year for a total $372,000 after six years. Also, she wouldn’t have saved for taxes so all tax payments would have been paid from her owner pay. Her taxes would have amounted to about $9,300 each year, totaling $55,800 after six years. Her total take home would have only been $316,200. This is $858,354 less than the expected $1.2 million! Suppose she’s happy she hired professionals and took reign of her finances? You bet she is!

In Summary

What do you think? Do these four steps seem like no brainers and easy to adopt? You’re right! They are!

Start the process today. Complete the first three steps by the end of today. Pick ONE sales strategy and ONE expense saving strategy discussed in the fourth step and start the process today! In three months, do it all again. By following this sequence, you will see improvements to your business’s financial health as early as tomorrow!

If you adopt these four steps, and if they work for you, then great! Let us know! Share your tactics, strategies, and experiences with us below. Heck share your current and needed figures so other business owners can see they are not alone. Plus, we’d love to learn what worked (and what didn’t work) for you so we can learn from you and continue to help others improve their financial health.  

If you struggle to adopt these four steps, struggle stick with your chosen strategies, or the progress is slower than your needs require, then give us a call and we’ll help you meet and exceed your needs!