Understand your financial statements

HOW MANY TIMES have you — or one of your competitors — uttered the following phrase?

"I wish my business was more profitable, I want my business to be more profitable."

If I had a dollar for every time I have heard this phrase in the years that I have been working as a business coach, I could probably retire early. The truth is that unless you are willing to do the hard work, make the tough decisions and learn how to use the numbers of your financials, nothing will change!

I know that many contractors who own a business today started out as a technician working for someone else. No one ever taught them the importance of understanding financial statements and using them as a tool. In the coming months, we are going to talk about using your financial statements as a tool to drive your business and achieve the profits you want and deserve.

First, when I say financial statements, I am talking about your balance sheet and profit-and-loss statement. If you are going to be a well-run company, you will have to be getting your profit-and-loss statement within 10 days of the end of the previous month. Many companies are going six months without seeing financial statements or knowing where their company is headed. This is kind of like you driving your car with your eyes closed or a wreck looking for a place to happen.

All that 'stuff' sitting around your shop and on your trucks has value.

Balance sheet

Let's start with the balance sheet, which records everything that your business owns or owes. Assets are owned, and liabilities are owed. Examples of assets would be cash in the bank, accounts receivables, trucks, real estate, trucks and office equipment. Liabilities include accounts payable, bank loans, and any accrued wages or taxes. The important thing to remember here is the formula: Assets minus liabilities equal the net worth of your company.

The balance sheet also can give you a couple formulas that will help you determine the health of your company. The Current Ratio Formula is your current assets divided by your current liabilities. This tells you how much you have in assets to pay off current liabilities. Bankers are looking for a ratio 1.5 to 2 for every dollar you owe.

The second formula is the Quick Ratio, which is cash and accounts receivable divided by current liabilities. Bankers are looking for a ratio of 1 to 1.5 for every dollar in current liabilities that you owe.

If your ratios are under the suggested guidelines, chances are that you are behind on paying your suppliers or, worse yet, on paying your taxes. If these ratios are out of whack, it may signal that you are not charging enough for the goods and services that you sell. While pricing is not the point of this column, please remember that your company gets money from only one major source — your customers.

I can hear you saying, "If I raise my prices, my customers will leave me."

That might be a good thing if all they want is cheap, cheap, cheap. It does not matter how much you sell through your company; it only matters what you deposit in your bank account.

And the reality is that most of your customers will pay whatever the price is as long as they feel they have received the proper value for the dollars paid.

Importance of inventory

One item that I often see left off balance sheets in plumbing companies is inventory. If you are not counting your inventory at least once a year, you cannot know what the true performance of your company is.

All that "stuff" sitting around your shop and on your trucks has value. You must count it and make sure you put it on your balance sheet to get the true worth of your business.

Should you ever be the subject of an IRS audit and do not have your inventory counted and extended out, you could be subject to penalties and interest. If you are not sure how to include inventory on your financials, contact your CPA for guidance.

In the next few columns we will discuss the actual profit and loss statement as well as the five key areas where you should focus your attention every month that will determine the success of your business. I will give you a way to model your business against truly successful businesses that achieve at least 10% net bottom line after the owners have paid themselves.

Mike Maynard is business coach for Quality Service Contractors, an enhanced service group of the Plumbing-Heating-Cooling Contractors-National Association. For more information about QSC, visit www.qsc-phcc.org.