Importance of Accounting

I have made the tough decisions, always with an eye toward the bottom line. Perhaps it's time America was run like a business.
— Donald Trump

One of the problems that I continually see in both my students at FSU and in entrepreneurs is the lack of understanding of financial statements. These are the core elements of any successful business and, honestly, it is almost impossible to manage a business without a complete understanding of them.

Now, the majority of my entrepreneurship students go out of their way not to understand numbers as they are marketing driven or “big picture” folks. It is my job to get them excited about entrepreneurial finance, which at times can be quite a challenge. Grade motivation does wonders for them; however, it is much harder with entrepreneurs.

I was meeting with a very nice man who had been an entrepreneur for over 30 years. Somehow he had been able to exist with very little knowledge about his financials. When I met with him to look over his financials, he knew that they were not right, but he had no idea how to make them correct. The most incredulous thing was that his accountant (a CPA) either saw no problem in how the financial statements were constructed (negative accounts receivable) or did not really care how the firm was doing.

This entrepreneur had no idea what his financial statements were telling him, and his only measure of financial viability was whether he had enough money in the bank. He thought this method had served him well, but he quickly realized that something was not right when I began asking him how different parts of his business were doing.

Just because you have money in your checking account or can make payroll does not mean that your business is doing well. I have seen countless businesses have strong cash flow one month because they were collecting on the accounts receivable; yet, no cash flow the following month because they were unaware that they were losing money until it was too late. Having money in the bank, just does not tell you how the firm is doing today or how it is going to do in the future. The only way to really understand this is to have monthly financial statements and to really, really understand what they mean.

What are some critical things to look at when evaluating financial statements? First, you need to understand what your gross and net margins are. Gross margin is just gross profit divided by sales, and net profit margin is just net profit divided by sales. Net profit margin tells you the net amount of profits you made on every dollar of sales.

You should be able to compare both of these figures against your industry information. For example, if your gross profit margin is 20% and the industry average is 40%, you are either selling your product too cheaply or paying too much for your products. With regard to net profit margin, I encourage firms to get as close to 10% as possible.

The next critical thing to look at is your expenses. I encourage each entrepreneur to go through all of their expenses line by line to make sure that they are what they should be. So many entrepreneurs just have no clue. When I have them do this drill, they wonder why their expenses are so high. If you do not watch out for your financial well-being, who will?

The other thing with which you should be vitality concerned is the amount of debt your business has. A little bit of debt is fine, but too much debt could lead to the demise of the firm. Debt, both interest and principal, must be paid off no matter what. In the case that you cannot pay it, the bank has the option of forcing you into bankruptcy. Obviously, this situation would not be good! Generally, depending on the industry, I recommend that firms keep their debt under 60% of total assets.

Looking after your financial assets is your job. You must have an understanding of financial statements to be successful. Now go out there and make sure that you understand your financial statements as they are so critical to your business.

You can do this!

Jerry Osteryoung is the Jim Moran Professor of Entrepreneurship in the College of Business at Florida State University. He is also the Director of the Entrepreneurship Program at FSU and Executive Director of the Jim Moran Institute of Global Entrepreneurship. He can be reached by e-mail at jostery@comcast.net or by phone at 850-644-3372.

Tags: Florida Small Business