November is the right time to adopt the REARview Mirror approach and conduct a review of your business. You need to know how your business is performing from a financial perspective. Why? Because the financial status of your business will dictate the longevity of your business model.
In Tilman Fertitta’s recent book, “Shut Up and Listen!” Mr. Fertitta outlines six key action items necessary for today’s entrepreneur. One of those action items includes knowing your numbers. Your numbers reflect the critical financial measures associated with your business. In fact, Mr. Fertitta’s lists several measures that you would find on your cash flow, balance sheet, and profit and loss statements. His key phrase is “numbers don’t lie.” I could not agree more.
Let’s simplify. I am absolutely in agreement that the more numbers you know about your business, the better off you will be. However, let’s review three critical financial measures that if ignored, place the longevity of your business at substantial risk.
Using Step 1 of the REARview Mirror approach, I will outline the three measures with which I am referring to. Recall that Step 1 is the “Review” step. It is the step that provides you with current state information. It is important that you complete Step 1 to understand how your business is performing from a financial perspective.
The first critical financial measure is Cash Balance, which is simply your current amount of cash and cash equivalents. Found in the Current Assets section of the Balance Sheet the Cash Balance will provide you with an indication of your potential liquidity position. It is important to note, that Cash is only part of the liquidity equation, albeit an important part. There are several liquidity equations (e.g. working capital, current ratio, quick ratio, etc.), but I like to start with Cash Balance because without Cash your future is pretty bleak. Another liquidity ratio that I believe is essential is the Cash Ratio.
The Cash Ratio tells you how much cash you have available in relation to your current liabilities. If this ratio is less than 1, then you do not have enough cash available to cover current obligations. That is a problem. Why? If you have no additional cash inflows, your current cash balance will not increase but decrease. Your current cash balance will diminish based on the amount of your current obligations. And, if you cannot cover your current obligations because your cash balance is reduced to zero, it will be difficult to sustain your business.
Operating Margin is Operating Income divided by Gross Revenues. Recall that Operating Income is the amount left over after you deduct Cost of Goods and Selling and Administrative Expenses from Gross Revenues. Essentially, Operating Margin will tell you the income realized from the core of your business. In other words, all direct expenses tied to your products and services are accounted for when calculating Operating Margin. Non-Operating items are not included in Operating Margin, which can certainly impact profitability. However, you need to know how your business is performing based on the core operations of your business.
In summary, the three critical financial metrics for you to incorporate in Step 1, the Review:
- Cash Balance
- Cash Ratio
- Operating Margin
Knowing these three metrics will allow to understand what needs to be further examined, which is Step 2 of the REARview Mirror approach to business assessment, the Examination.
Bypassing Step 1, “Review” and going directly to Step 2, “Examination” may allow you to miss something significant happening in your business. You need to understand your current state, first and foremost. Then, and only then, will you know what needs further examination to adjust for better future outcomes.