In any business, there are a couple of key functions within that business: 1) making the product (or buying and preparing for sale or lease in our case) and 2) selling the product (or home). Sometimes, those are covered by a single individual.
However, the third and most important function of running a business often gets neglected: 3) the finances. We tend to assume our banker, accountant or spouse is taking care of it; but many times, we don’t even think about it. Therefore, this task is actually performed by NO ONE! We just deposit the money, write the checks, and hope everything works out okay. This is like leaving prime rib out to thaw with your German shepherd on the loose and hoping it is will still be there when you get back.
Seldom does this work out to your advantage. Without specific instructions, your banker, accountant and sometimes, even your spouse will not do what is really needed. Remember, no one cares about your bottom line more than you do. Fortunately, many have gone ahead of us in business, and we can learn from them what we need to do.
To measure your business’ performance, you have 2 main tools: the profit and loss statement (P&L) and the balance sheet. These statements show you where you are at present and can be used to forecast your financial future. Based on what you have done or what your goals are, you can create a written business model or forecast.
In creating that model, you should ask questions like:
- “Do I have cash or need a loan?”
- “How much do I need?”
- “How long will I need it?”
These are crucial questions to answer, preferably far ahead of time, so as to reduce stress for you and those around you. Even though each business is different, by properly interpreting the P&L and balance sheets, you (and/or your power team) can forecast fairly accurately.
The P&L measures growth along with profit, and the balance sheet measures the cost of that growth. Is it possible to grow and run out of money? It happens every day! If your business is growing or cash flow is increasing, you may not even realize that you are not generating a profit. The inverse is also true, which may be even worse. If you are making a healthy profit but do not have the cash flow to get you through the slow months, you could be out of business long before you get to realize next year’s profit. Your penalty for not planning will be the loss of your financial reward for next year. Bigger is not necessarily better; you need to find the volume that works for peak profitability.
A lack of cash flow can, and often will, kill your business faster than a lack of profit. This is why we must understand BOTH.
There is a lot involved. So how much do you need to know?
The more you understand, the better. Start by reading as many books as possible on financial literacy, go to seminars, take some classes at a local college and buy your accountant or banker lunch as often as he/she will let you (and ask a lot of questions). The more you understand, the better you will be able to see and understand a financial problem. Even more valuable, the better you will be able to foresee a potential problem.
You don’t necessarily need to know as much as your banker or accountant, even though that would be great. This is why we pay them and have them on our team. You do, however, need to be able to speak to them intelligently, using the correct terms. If you do not know how to talk to your banker and explain your financial statements, he/she will have less confidence in you and may not want to loan you any money. Or what may be just as bad, he/she may loan you too little.
Why would he loan you too little? Usually, it is because that is the precisely amount that we ask for – too little. If you do not know how to forecast the amount you need, you need to understand concepts well enough to ask your banker to help you figure it out. If your banker can’t help you, then find a new banker. If your banker loans you too little, it will hurt you both in the end, as you are setting yourself up for failure and your banker to take a loss.
Where else can money come from besides a banker? You have net profits, hopefully, your own money (usually not very popular among business owners) and vendor credit. Vendor credit is a good way to get cheap, short-term money. By extending your terms or even making payments on time, you can get money very cheaply. Keep in mind even money from a bank or a hard money lender is cheap if that is the only way that you can make the profit that you planned.
Your accountant is, of course, just as valuable; but he/she will only do the work that you tell him/her to do. Your accountant will not plan for you unless you pre-arrange to meet and ask for his/her help. He/she will sometimes not be willing to educate you; but hopefully, if you ask, he/she will. This is just one of the reason why I stress: Interview your power team members carefully and educate yourself constantly along the way.
The cost of the money may be thousands of dollars. Knowing how much to ask for – priceless.
By Mark Gilliand
Rich Dad® Education Elite Training Mentor