The small business diet

Losing weight is not easy but we all know it can reap amazing rewards. Calorie counting is boring but the basic equation is that calories out must be greater than calories in to actually lose weight (allowing for what is needed just to exist or stay as you are).

However, achieving a longer lifespan, being fitter, feeling and looking better (both physically and mentally) etc etc makes us all more productive - and it would take a very brave (or overweight and unfit) person to dispute that. 

With a few exceptions (medical or genetic) there are many ways to improve your health and well-being by altering diet and/or exercise in various proportions to suit your lifestyle and goals.

Your attitude towards your business should be no different. In order to achieve longevity the business needs to be lean and streamlined (i.e. efficient). This is even more important if you want it to become bigger and stronger (i.e. more profitable). Just as with weight loss or diet and exercise strategies there are books, TV shows and self-help programs for small business management – yes, even TV shows (see the excellent Kochie's Business Builders). Most of these offer great advice and what works best for you is probably a selection or combination of ideas.

Among the many strategies we have available are:

1. Lose weight, trim the fat or cut costs. Ideally costs and overheads should be at the optimum level for efficiency – not as low as possible as this is often a short term strategy which can be devastating in the longer term. Instead consider the marginal impact of a cost item – does it positively contribute to the business or would business suffer if it were cut.
2. Alter your diet – manage the revenue.  After analysing your business by product or service, consider whether you should be changing your sales mix or marketing strategies to focus on more profitable lines.
3. Do more exercise – increase or improve your marketing strategy. Be more aggressive or active in your market – or enter another market. Become seen as an expert or authority in your field drawing attention to yourself – and by inference to your business.
4. Use a nutritionist or personal trainer – or both. Outsource parts of your business to someone who specialises in that area and can do it better or more efficiently – allowing you to concentrate on what you do best (and make money!).

You have probably already got a plan for a long healthy life and a rough idea of what you will be doing in 5, 10, 20 or even 50 years! By no means is this set in concrete as you want to be adaptable and take advantage of opportunities as they come along.  You business is no different. Do you have a plan? What is your exit strategy? Do you just want to continue as you have and shut the doors at some point in the future or do you want to build as asset that can later be sold to fund your retirement?

So how are you going to approach the New Year? Lose weight, bulk up, get fit or do a combination thereof?

However you celebrate, remember to enjoy life and have fun in business - but always in moderation and consider the consequences!

Measure by numbers....but not just dollars

Congratulations if you've read past the title because it might seem a contradiction. Of course you measure in dollars - it's called bookkeeping. But how far does that get you? 

Raw data

As well as being a legal requirement you can't plan and manage your business if you can't see or measure what is happening. It is essential that the data is being recorded consistently and accurately and in enough detail for you to be able to use it - but not so much so that it becomes a chore and is not useful for anything! Many small businesses use the data to populate their tax return...and leave it at that. 

Accounts 

A step up in terms of managing your business is to prepare accounts, whether on an annual or more regular basis. Comparison against prior year figures makes the exercise more meaningful and you can start to draw some conclusions. However doing that often raises more questions than it answers. For instance you can see your sales have increased in a particular category (as you have recorded sufficient detail) - this is great but is it due to increased productivity, more or better marketing, better inventory management or something else? And how has this affected your cash flow, eg higher sales can translate to less cash if you had to offer longer payment terms.

Timely

So producing accounts has given you some more information, but this is historic and may have little relevance to current or future business decisions. Ok, all measurement will be historic but by producing it regularly and timely, accounting data will become much more useful. Carrying out regular forecasts is also invaluable - these will usually be based on current, up-to-date business data taking into account known or expected changes to your market or business model. Measuring your current data against a previous forecast will also help you draw conclusions, both about current performance and efficiency.....and your forecasting assumptions and techniques.

Analysis

Businesses exist to produce profit, but the key to good management is how that profit is produced. You are selling goods or services and the efficient ability of the business to do that is what determines the profit. Therefore it makes sense to measure in terms of those good or services. Each business is of course very different but objective analysis vastly improves the relevance and applicability of your management information. What I mean by this is analysis by:

•    Product that could be per litre, carton, case, room or whatever unit is most applicable (just don't overcomplicate it!)

•    Services are a bit harder but can still be done e.g. billable hours, hours paid, staff numbers, floor space or whatever is most appropriate for you

•    Combinations such as measuring sales by unit but perhaps overheads by week if they are relatively fixed in nature

By just adding this extra layer into your analysis your accounting data becomes much more valuable. Instantly you can see if an increase in sales revenue over budget or last year is due to item price or volume or a combination thereof. You could measure by unit by market to give even more useful information and so on.

Once you have all this valuable analysis you can start to draw meaningful conclusions and make any changes necessary. Of course you need to be aware of paralysis by analysis so only be as specific or detailed as is practical, either to draw conclusions, take action or to measure and record data in the first place.

Get fit for business with the Retail Doctor

I have just attended a business breakfast that was hosted jointly by the Balmain/Rozelle and Leichhardt/Annandale Chambers of Commerce. There was a very interesting speaker, Brian Walker (aka the Retail Doctor) and I thought what he had to say would be of interest to many of my followers, as well as to local retail precincts in general.

There was a lot of information that I won’t (or can’t) attempt to convey in totality – merely to comment on what stood out most to me, and my interpretation of it. For more information from the source please go to www.retaildoctor.com.au.

Multi-channelling

The whole retail landscape has changed dramatically over the last decade. However, and despite the protestations of Gerry Harvey and others, online sales account for only 7% of retail sales. Brian estimates that in five years this will have gone up to 12-15% - hardly signalling the demise of the bricks and mortar store.  Shopping online has had a lot of media attention but that doesn’t mean online-only retailers are sitting pretty – one of the biggest, Amazon, has only recently started to turn a profit.

There are multiple facets or channels in the whole shopping experience. These range from the more traditional high street shopping strip, large shopping malls, catalogues and mail order to websites, e-commerce, blogs, or social media. These are constantly evolving and changing – for instance there is a move in Australia from malls back to a community ethos of high street shopping.

Each method appeals to different demographics in different ways and there are not many retail businesses that can just stick to one or even two channels – unless perhaps they are in some sort of monopolistic position.

Cross-channelling

The proportion of customers who research before buying is very high, particularly for high ticket items – whether this is online before buying in-store, in-store before buying online or any permutation thereof, not forgetting the research (or sale) may be done with the competition.

Research will also be done with other customers, past and present. This can be face to face or increasingly through online reviews and social media. The latter cannot be underestimated, as previously word of mouth was one-to-one, now it is to the whole world and sometimes can make or break a business.

So not only should a retailer use multiple channels, but these channels must be complementary and guide an existing, new or potential customer to the ultimate goal of a sale.

Shopping experience

Good customer service, pricing and good staff are not really unique selling points – not many retailers would admit to falling short on any of these. Rather they are just expected and are prerequisites to being fit for business and growth. What businesses can compete on successfully is providing an experience.

Customers are people who have five senses to which you can appeal. Online you can (currently) only appeal to two, sight and sound. Of course there are many other ways to attract a customer such as having a unique product, appealing to vanity or fashion, or just good marketing (“you can’t afford not to have this product!”).

Whatever the strategies or channels used the experience needs to be about the customer – but keep it real!

How do you put together a financial model?

The quick answer is anyway you want - there are no rules but there is best practice, and following that will make the process more efficient and increase the credibility and shareability of the results. A forecast (or budget or other projection) in its simplest format is plotting values against time periods (generally weeks or months). However if you want more than a one-off exercise or for the forecast to have some level of credibility (either to you or another party) you will need a financial model.

A financial model is a theoretical representation of a financial decision-making process or project. It is a mathematical model designed to represent financial performance.

There are a number of elements that make up a good model:

Variables

To give credibility to the model each line of the model should be supported by calculations and showing the assumptions and methodology used e.g. $x per unit sold or per week/month. This also allows for scalability and can be backed up by evidence e.g. invoices or sales projections.

Sensitivity

Variables or input fields should allow changes to be easily made (to values or methodology) so as to instantly flow through the model and show the effect on the final result. This is sensitivity or what-if analysis.

Rolling periods

The model should allow for future use to add on additional, or roll forward to later periods. This should be able to be done in a relatively straightforward manner without having to rewrite the model.  This keeps it dynamic and the process continual and consistent.

Format

The outputs of the financial model (whether Profit & Loss, Cashflow or other Statement) should be relatively easy for another user to read and understand and be in a familiar format such as the regular management accounts. In addition the assumptions and inputs must also be straightforward to read and update. The backend, or calculations, of the model should also be logically laid out and be consistent to allow for possible future changes or updates.

Integration

Ideally the model should produce both a Profit & Loss (P&L) and Cashflow statement to give a more complete and thorough picture of the business or project. A Balance Sheet (BS) should also be included to act as a check as well as provide information. The opening BS plus P&L and Cashflow movements will give a closing or current Balance Sheet.

Not all of these elements are essential and some may be omitted depending on desired outcomes, audience and time or other resource constraints.

There are templates, programs and other tools available (many free of charge) for business owners or managers to utilise. An Excel spreadsheet is the most widely used tool for reasons including flexibility, ease of use, cost and portability or sharing.

 However the process will usually be far more efficient if it can be delegated to a qualified staff member, or outsourced to a professional, to manage the completeness and integrity and allow you to stay focussed on the business inputs and outputs.

Profit & Loss and Cashflow Statements – what’s the difference?

They both provide different information about a business – this difference may be minimal (especially for small or micro businesses) or quite substantial.

The Profit & Loss Statement or Account is also commonly known under other names such as an Operating Statement or Statement of Financial Performance. It measures the profitability of a business – that is the return on it’s trading or day-to-day operations. This is also known as the revenue side of the business - as opposed to the capital side, which is all about investment, funding and equity.

A Cashflow Statement shows all cash and bank movements belonging to the business. A Bank Statement may serve this purpose, particularly if it contains all the business funds (ie no other accounts, loans, floats or other cash or cash substitutes). However this is usually summarised Cashflow Statement and shown in a format which gives useful information such as by categories, by month rather than a merely a list of receipts and payments. It includes transactions that are either revenue or capital in nature. The Cashflow Statement measures the liquidity of a business and is a key indicator of solvency – that is the ability of the business to meet its debts and liabilities.

For very small businesses, or those with low and negligible timing differences a Cashflow Statement alone may be sufficient. By timing differences I mean the lag or amount of time between issue of invoice and receipt of payment, and between receipt of purchase invoice and payment made. The Australian Tax Office generally only requires small businesses (usually with turnover up to $2m) to report on a cash basis.

Where reporting on a cash basis is neither permitted nor sufficient the accrual basis is used. This then produces the Profit & Loss Statement. The accrual basis means that revenues are matched with associated costs regardless of when they actually arise. A simple illustration is a wholesaler might buy their stock in March but nor sell it until April – both transactions will be reported in April’s Profit and Loss. In accounting terms this matching is done through tools such as inventory management and the recording of accruals or prepayments.

Either Statement on its own will tell a lot about the company but they need to be considered together to get a clearer picture. For example a business that is otherwise profitable may not be good at collecting debts, or is paying its bills ahead of terms, which puts cashflow under considerable strain and may negatively affect solvency. The longer invoices are outstanding the greater the chance of a bad debt occurring – when this happens they will be reflected in the Profit & Loss but this is too late for remedial action.

Generally the more ways you can look at information the more it will help with the management of your business. It is also vital that it is good quality information which makes it so important to have a good system set up from the beginning with good, accurate and timely data recording.

Chart of Accounts: mapping the genome of your business

To use this medical metaphor financial records will be a meaningless jumble of nothing, a blob of ectoplasm, without a chart of accounts. The chart is a map of the business – a list of unique nominal ledger accounts or records that break down the business into its constituent parts.

This chart can be laid out in any pattern but to be most useful there should be a logic, methodology and consistency to support it. The list of accounts and their balances at any particular point in time is called a Trial Balance. This is just a list, so in itself is not terribly helpful apart for checking the control of debits equalling credits. Producing financial statements is the application of this database to show the performance and position of the business.

The chart of accounts is generally grouped into ranges of accounts:

• Assets
• Liabilities
• Equity
• Revenue
• Cost of Sales (or direct costs)
• Expenses (overheads or indirect costs)
• Non-operating income and expenses

Depending on the business these ranges may be further subdivided into income/cost centres and/or business divisions….or really in as many ways as management want to look at the business. The more detailed the chart then the more possibilities for analysis – although each layer of additional detail requires more work and increases the chance of inaccuracy or error.

Businesses want as much useful information as possible, while avoiding paralysis by analysis. If the objective is to populate a tax return a limited chart is all that is required – albeit with some specific requirements. A solo or micro business may not need a long list of accounts if it is relatively easy to control. However more detail is always better than less as more reporting options become available – this needs to be balanced against the effort and resources required. The determining factor is what information you require, or may be likely to require in the future.

For ease of use and versatility accounts are nearly always given codes. These can be numerical, alphabetical or a combination of both. The number of digits will depend on the level of detail and hierarchy chosen. Depending on the recording method (usually software program) the basic structure may be pre-determined but otherwise there is no set format – but again logic and consistency should prevail.

The reason the chart of accounts should be decided at the outset of your business is that the more time goes by, with data collected, the harder it is to change your chart or add in more detail – harder but not impossible! For instance do you only need one account for income or multiple accounts for different revenue streams or products?

Designing the chart of accounts may seem like a daunting task with a lot of considerations, present and future, to take into account. However you generally don’t start from scratch. There are numerous pro-forma lists around which may suit your industry - perhaps within the software program used or on the Internet. Your accountant will probably have a suitable structure you can use and in any event they should be consulted for their input and feedback before implementation.

Debits and credits – what are they and what do they mean?

Debits and credits are the names given to each side of a double-entry bookkeeping transaction. Business transactions are stored in records or ‘accounts’ whereby similar transactions are grouped together. These accounts are made up of debits and credits and will show a balance which is total debits less total credits (this may be zero in some cases).

By convention debits are on the left and credits on the right (or sometimes shown as positive or negative numbers respectively). This is purely for consistency and ease of use and does not in itself have any meaning.

As the system has to have a point of origin, assets are debits and liabilities credits. This doesn’t mean you can’t post the credit side of a journal to an asset account – you can, it just means that it is a reduction in the book value of the asset (most likely depreciation). Similarly you can debit a liability, which reduces the value of that liability – such as a payment to a creditor reducing what you now owe to them. Equity (or Capital) is usually treated as a separate category but it is really just a (non-current) liability of the business to the owner or shareholders.

OK, so that is the balance sheet side of double entry but because it is a self-balancing system the principal equally applies to the profit and loss account. Here debits are costs or overheads and credits are income or revenue – you can think of it as income being an increase in owner’s equity.

DEBIT	CREDIT
Asset	Liability / Equity
Reduce Liability	Reduce Asset
Expense	Income
Reduce Expense	Reduce Income

A frequent comment on this is “but I have a positive bank balance which is in credit”. This does cause considerable confusion, as it is where most business owners are likely to come across the debit/credit terminology. It is not a contradiction – to the bank your bank account is a liability, they owe you that money. It is perhaps just egocentric of them to display information to the customer from the banks point of view.

A more helpful way to look at this is to equate it with buying something on credit which is very common and easily understood. In bookkeeping parlance you are crediting your general ledger credit card account and debiting whatever the transaction was – either an asset or an expense.

The terminology is often abbreviated as debit (Dr.) and credit (Cr.). An example of a journal transaction as it would be written or posted to a ledger account – an electronic bank payment to pay for a reference manual:

Dr.	6-3300	Books & Periodicals	$50.00
Cr.	1-2010	Bank Account		$50.00

The above codes are fictitious and will depend on the structure of the chart of accounts – which will be subject of a future post…..

A change is as good as a rest...or even better

Finally, I’m happy and everything is in its place (sort of!). Moving office can be a daunting experience but once done, brings a great sense of satisfaction and an impetus to do more work (or write a blog!). Not that my experience was a huge change in real terms – except to me! I swapped my office and bedroom.

To put this in context the bedroom was at the back of the house overlooking a park – great outlook and fantastic light. The office was in the ‘spare room’ that is a bit smaller and much darker as it doesn’t have much direct natural light – which I love. That didn’t make for an overly productive work environment but my mindset was that the bedroom should have precedence and be in the nest room. There is an easy chair in the bedroom with a footstool – I love it but was always banging my shin going around the bed. After hearing this a few times my partner suggested why not swap around the rooms. Initially I didn’t think much of this but it got me thinking……

I spend much more of the day in the office whereas the wonderful light in the bedroom was largely going to waste. The easy chair could also stay in the ‘new’ office with more room for the footstool – a great place to read documents and texts. There was a phone connection in both rooms so that wasn’t a constraint. Ok, decision made…work to do.

Well, it didn’t really take that long to do and after a few trial layouts (and more advice) I had a great office – better structured and above all, a better working environment. The other side of this is there is also a terrific new bedroom – although it is slightly smaller it is a different shape, which is actually far more conducive to fitting in bedroom furniture. The fact that is darker is also a good thing and aids sleep. The other benefit of the big move was that it was an excellent opportunity for spring-cleaning and re-organising (and finding things that I forgot I had!).

Now why am I sharing all this? I know one of the reasons I enjoyed the whole exercise was that I like change – but only if I think (at the time) it makes me more efficient with my use of time or resources. Shifting around my furniture from time to time is something I’ve always done – without analysing the why too much. This is also how I approach my spreadsheet financial models.

Constantly thinking about ways of making them more efficient, smaller in size or with less detail – while at the same time giving more relevant results and being more user-friendly – this is especially important if others are to use them as well. Starting to use a spreadsheet that has been developed by someone else usually has a steep learning curve and the more sophisticated the model the longer this takes. Of course a good modeller will use methods and techniques that can cut this down greatly (such as putting assumptions and variables together on one page rather than scattered throughout the spreadsheet).

From time to time this means that the whole spreadsheet gets turned on its head if you come up with a different way of looking things (such as allowing for a breakdown by day if you’re looking at coming up with both weekly and monthly data – and that doesn’t have to be as hard as it may sound). Also if the you or the client wants to introduce another variable into the picture (such as multiple cost centres with individual reports) that might require a radical reworking of the model.

Of course the other side of all of this is that you can’t spend too much time on change or re-organisation or do it too often – it can be a good way to prolong procrastination or to defer something. However if done right it is another and better way of looking at things, whether that is your workspace, personal life or a financial model of your business.

Double Entry Bookkeeping - What is it and why should you know?

Bookkeeping, as the name implies, is the recording of financial transactions of a business. The double-entry concept is a set of rules that has been universally adopted and around since the 12th century. It was famously codified in the late 15th century by Luca Pacioli, an Italian monk.

Ok, enough of the history lesson. As the name implies, every transaction has two sides, (known as a debit and a credit). For example a cheque or other payment affects both the bank account and a cost category. A sale creates income as well as a debtor (or money in the bank). It is possible for a transaction to involve more than two entries but the total debits must equal the total credits. Things like the GST and inventory management will complicate this by creating additional entries – but the basic rule still applies.

A transaction is entered (“posted”) as a journal into the accounting system (whether this is software, a book or ledger or a cloud application – see future newsletter about the latter!). A journal shows the account name (or code) for each debit and credit created by that transaction. Part of this may be automated as a ‘specialised journal’ so you don’t see the transaction in this way, for example

• A payment will automatically credit the bank account so only the debit needs to be manually coded)
• A sale or invoice will automatically debit Trade Debtors (Accounts Receivable) with the credit then coded to the appropriate income account

Often when a journal is posted from scratch (select debit and credit) it is called a general journal.

The beauty of this system is the inbuilt data integrity check, or internal control.

• Each transaction updates the balance of an account (whether that is the bank, debtors, income or expense) that can be independently reconciled and verified (such as to a bank statement, list of debtors, invoice register etc).
• A list of the balances in your accounting system at any point in time is called a Trial Balance. The total debits must equal the total credits (or the overall total of balances must be zero if credits are shown as negatives which is sometimes the case).

This is not a guarantee of error-free accounting but can reduce the risk – the wrong ledger accounts may still be used.

Now, I can hear many people asking why should they know this? Well it is very difficult (if not impossible) to make a system work for you if you don’t fully understand how it functions – not necessarily in detail, but at least conceptually. That is, unless you’re looking after the bookkeeping yourself, which many of us are – in this case an understanding of the subject will help you to more efficiently use your accounting software which uses the same principles....

What or how much, accounting does your business need?

The way your bookkeeping system and chart of accounts are set up will largely be determined by what type of accounting you want. You don’t want to put time, effort and money into detailed recording of transactions if you are not going to use all that information. Do you need or want to have the ability of producing top quality reports about your business now or in the future? The size and structure of the business may predetermine some or all of this but for small and medium enterprises [SME’s] there are usually more options available.

Tax Accounting

Many small and microbusinesses only need, or want, their bookkeeping to be able to produce reports and summaries which can be given to their tax advisor to do the annual tax computation. Minimal detail is required but there are specific requirements which you will need to meet – such as on entertainment, assets and personal v business use as appropriate. If the business is required to register for GST more detail will be required but again, if tax is the sole motivation then a relatively simple (and probably cheap) system can be maintained.

It is best to seek tax advice as early as possible from your accountant. Also you may be able to reduce their bill if your records are well kept and in order.

Financial Accounting

This is generally associated with compliance – whether with the Corporations Act or other legislation, or indeed with other requirements such as a debt covenant or external investor or stakeholder.

There are strict rules and guidelines which reports must follow, such as IFRS [International Financial Reporting Standards], and that will determine in turn how the accounts need to be set up. In most cases financial accounts or statements will also be subject to external audit.

Management Accounting

This area of accounting is the least defined but probably the most useful to SME owners or managers. It is generally more detailed and tailored to each business – and also to must be able to produce and be consistent with tax or financial accounting reports as necessary.

Management reporting shows the business the way the owner wants to look at it, generally focussing on KPI’s [Key Performance Indices] which are the drivers of the business. The analysis should be in practical terms that can be used to grow or make the business more efficient – such as revenue or cost per room for a hotel, or per litre for a fuel business, or percentages for a service business etc.

The detail, accuracy, consistency and timeliness of the bookkeeping will determine how informative, reliable and timely the reports are – and ultimately how useful they are.


So whether you manage your business based solely on the bank statement or on detailed reports and analysis, the accounting will determine the resources needed and the desired outputs will determine the type of accounting.