Every week as SmallBizLady, I conduct interviews with experts on my Twitter talk show #SmallBizChat. The show takes place every Wednesday on Twitter from 8-9 pm ET. This is excerpted from my recent interview with @ruthking. Profitability Master Ruth King is a serial entrepreneur having owned 7 businesses in the past 30 years. Ruth has been instrumental in helping small business owners understand and profitably use the information generated from the financial segment of their businesses. She has a knack for helping business owners truly understand financials.
After twelve years on the road, doing 200 flights per year, she knew there had to be a better way to reach business people who wanted to build their businesses and train their employees. She began training on the Internet in 1998 and began the first television like broadcasting in 2002. Her latest channel is profitabilityrevolution.com, helping small business owners run their business better, make money, live better, enjoy freedom, and give back.
SmallBizLady: What is most important – cash, cash flow, or profit?
Ruth King: You need profitable sales that turns into positive cash flow that turns into cash. The first step is collecting your profitable sales. The sale doesn’t count. Only collecting the cash from that sale counts. If the sale is not profitable even when you collect the money from that sale, then your cash flow becomes smaller and smaller until you run out of cash. If the sales price is less than your cost, then the more you sell the quicker you go out of business.
SmallBizLady: What financial information do you need each month?
Ruth King: Review a monthly balance sheet and profit and loss statement. These financial documents should be accurate and timely. You should receive them by the 10th of the next month. You also should receive a weekly cash flow statement each Friday afternoon so you can plan your cash needs for the upcoming week.
SmallBizLady: What is the difference between cash-based and accrual-based accounting and why should you run your business on accrual-based accounting?
Ruth King: In cash-based accounting, you account for a sale when you get payment for that sale. You have an expense when you write the check for that expense. There are no accounts receivable, accounts payable or inventory.
In accrual-based accounting you account for a sale when you send the invoice to the customer, whether or not you got paid. You account for an expense when you receive the bill from your vendors. You have accounts receivable, accounts payable, and inventory.
Accrual based accounting shows true profitability, as long as revenues match expenses against those revenues in the same month. You’ll also keep better track of your accounts payable and monies owed to you from your customers.
SmallBizLady: What is net profit per hour and why should you manage your business by net profit per hour?
Ruth King: Net profit per hour is the total operating profit you made last year (before other income, other expenses and taxes) divided by the total revenue producing or billable hours. Count only the hours that you had to make your products or produce your services. Receptionist hours, bookkeeping hours, and other office personnel hours don’t count.
Manage your business this way because it doesn’t matter what your top line (i.e. sales) is. It matters what you bring in for every hour that produces that revenue.
SmallBizLady: What is overhead cost per hour?
Ruth King: Overhead cost per hour is total overhead divided by the total revenue producing or billable hours (same divisor as net profit per hour).
You need to know for every revenue producing hour, how much overhead that hour needs to cover. This helps you establish your true pricing.
SmallBizLady: Why is the balance sheet more important than the P&L?
Ruth King: Balance sheets tell you true profitability over a long period of time. P&L’s only tell you whether you were profitable for a short period of time (one month or one year), then they start over.
Balance sheets also tell you whether you can pay your bills, whether you have too much debt, whether you are heading for a collection problem, and whether you have too much inventory.
SmallBizLady: What are the most common mistakes on a balance sheet?
Ruth King: Negative cash. You cannot have negative cash in the bank. You would pay excessive overdraft fees and the bank would close your account.
Negative payroll taxes payable. It is unlikely that the Federal and state governments owe you money for payroll taxes. Normally when you see this, the bookkeeper has entered payroll incorrectly.
Negative loan balances. Your banker doesn’t owe you money for loans. This is usually an error where the bookkeeper has taken the entire loan repayment against the loan rather than just the principal repayment. Interest is an expense, which goes on the profit and loss statement, not the balance sheet.
Inventory is the same amount each month (for companies who have inventory). Inventory changes each month as you sell your products. Not accounting for inventory properly can cause huge write offs at the end of the year when you take a physical count of your inventory.
SmallBizLady: What are the most common mistakes on a profit and loss statement?
Ruth King: Not matching revenues with expenses in the same month. If you don’t match them, then you will have great months (when there is revenue and no expense) and terrible months (when there is expense and no revenue).
Having no rent or double rent in one month. Rent and other normal monthly expenses should be the same, or about the same each month.
Counting a yearly payment in one month. For example, if your insurance payment is due once per year, that is an expense that must be divided by all twelve months rather than showing the expense only in the month you pay it.
SmallBizLady: What is a weekly cash flow statement and why should you use one?
Ruth King: A weekly cash flow statement tells you what cash you have on hand, what got collected (came in the door) that week and what bills you paid that week. It also looks at the following week by estimating the receivables that should be received, the payroll expense, and the other bills that are to be paid that week.
If you don’t have enough cash to pay all the bills the following week, you will see it the Friday before and can make collection calls to bring in the cash you need to pay payroll and other bills.
SmallBizLady: How do you analyze your monthly information?
Ruth King: Calculate the ratios and plot them on a graph so you can see the trends.
Some of the ratios are:
- Current ratio: current assets divided by current liabilities
- Acid test (quick ratio): current assets minus inventory divided by current liabilities
- Accounts receivable to accounts payable: Trade receivables divided by trade payables or trade receivables plus cash divided by trade payables if more than 50% of your sales are COD.
- Debt to equity: total liabilities divided by total equity (net worth)
- Long term debt to equity: Long term liabilities divided by total equity
- Productivity ratio: total payroll and payroll taxes divided by sales
SmallBizLady: What is the best way to keep the honest people honest so they don’t steal from you?
Ruth King: Send your bank statements home. You should be the first to see them. Look at the microfiche pictures of the checks. Make sure they are the right amounts and have your signature on them. Question any check that doesn’t look right. Question automatic withdrawals or other electronic payments that don’t look right.
You will also see bounced checks, loan payment notices, and other notifications from your bank first. Your bookkeeper might be hiding some of these from you.
SmallBizLady: Why should you never allow your bookkeeper to sign checks?
Ruth King: If she has check signing authority, she can sign any check, for example, including ones to herself, her lawyer, her power company bill, or her company (which might have a similar name to one of your real vendors – i.e. ABC Corp and ABC Company). If she embezzles, it is not a criminal offense – only a civil offense because she had check signing authority. This makes it harder to prosecute her.
“Purse Full Of Dollars” courtesy of Supertrooper / www.freedigitalphotos.net
If you found this interview helpful, join us on Wednesdays 8-9 pm ET; follow @SmallBizChat on Twitter. Here’s how to participate in #SmallBizChat: http://bit.ly/1hZeIlz
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Am really impressed on the interview. We love to enroll in your class Melinda.