There are two ways to run a small business today—one by the seat of your pants and the other by the numbers.
In the past, with the significant margins on equipment and minimal competition, an electronic systems contractor (ESC) could succeed by running the business by the seat of his or her pants. But not anymore. I predict that those companies will not survive; the only companies that will be around next year are the ones that understand their numbers and use financial information to make informed, strategic decisions.
In this series, we’ll be looking at how to use your financial statements to manage your business. Many companies only generate financial statements to give to their accountant for tax returns, but we’ll see how creating and analyzing monthly financial statements can provide the information you need to make decisions. For example, if your volume is falling and you are being pressured by customers to reduce your prices, how low can you go? The only way to answer this question is to have accurate financial statements.
Analyzing Statements
The first step is to look at your Profit and Loss Statement (P&L) or Income Statement. All costs should be split into two categories, costs directly related to the job (Cost of Goods Sold-COGS) and overhead costs. It sounds simple, but I can’t tell you how many times I’ve seen financial statements that are a mess. All too often, companies do not track production labor to specific jobs. They complain that it’s too hard to get time cards, or the system won’t track job costs. My first response is: “who’s running your company, you or your employees?” Second, all systems, even QuickBooks, will job cost your payroll, but only if you set it up to do so.
However, even with the best intentions, it still may be hard to interpret your P&L. In this industry, the difficulty occurs because the timeframe of your financial statements may not match the timeframe of the jobs. In order to create accurate P&L statements, you need to consider an accounting standard called the “Matching Principle” in which the amount of income you show is related to the costs that you’ve actually incurred.
This means that if the COGS on your P&L shows 25 percent of the expected costs of a job, you should show 25 percent of the expected revenue and then be able to show 25 percent of the expected gross profit. This is the only way to make your financial statements meaningful.
