In a previous blog post, I spoke to Ana Harvey at the SBA about the importance of setting goals for growing a business. Recently, I’ve been thinking about the importance of setting financial goals. What often holds small businesses back is the “disconnect” between their business goals and financial reality.
For insights on how small businesses can use their own financial statements to devise better plans for growth, I spoke to John Harmon in Portland, Maine at one of the stops on OPEN’s Small Business High Speed Growth Tour. OPEN created the tour in partnership with SCORE, a nonprofit that offers education and mentoring to entrepreneurs nationwide. John is a volunteer with SCORE and leads workshops on small business finance. When I asked him about goal setting and common pitfalls, his focus was immediately on the numbers: “Many small businesses fail to forecast future growth. If a business’s goal is to grow, forecasting is an essential step.”
Break down your plan
Having a revenue goal isn’t enough. “Decide where you want to go and then build a plan,” John advises. “If you want revenues of $1 million next year, then break things down to understand what it will take to get there. How many units will you have to sell, or how many hours will you have to bill? And at what price?”
Once you know in real terms what it will take to reach your goal, you can then build a plan and make the necessary changes, whether that means targeting new customers, entering a new market, or offering a new product or service to increase revenues.
Stay on course with financial ratios
Once you have a plan, you’ll have to track your financial progress to make sure you’re on course. When it comes to understanding financial health, look at financial ratios, as opposed to single figures from your financial statement.
“There are four types of financial ratios: liquidity, profitability, leverage and efficiency,” John notes. And while these categories include hundreds of financial benchmarks, the trick is to decide which are most important for you business. Some of the most common are:
• Days of cash: how many days will available cash cover liabilities?
• Days of inventory: How many days does it take to turn over inventory?
• Gross profit margin: What percentage of money is left from sales after subtracting cost of goods?
• Debt to equity: How well is debt being leveraged against capital invested by owners?
There are many ratios you can look at to keep your business in good financial health and on course to meeting goals. If you don’t already manage your business through financial ratios, speak to your accountant or other trusted advisor to better track your business’s health and progress.
Finding help to reach your goals
John observes that simply minding financial health isn’t always enough to meet goals. Growth often requires expensive changes, such as breaking into new markets or developing new products. “Many small businesses underestimate the cost—and time—needed to make the kinds of changes that will lead to significant growth,” he cautions. “Additional funding through loans or investors will often be needed.” The good news is, John adds, is that lenders will look favorably on well-balanced financial ratios.
Former banker and owner of M2Fraud & Risk Management Mary Gaskin, whom I recently met at a SCORE event, echoed this opinion. She pays careful attention to her own financials, and is aware of how closely potential lenders scrutinize them. Commenting on challenges small businesses encounter when seeking loans, she notes that lenders immediately look at a business’s financial ratios, such as the debt to income ratio, among many others. So it’s vital to know where your key ratios stand well before you seek a loan.
If you’re interested in learning more about how you can better understand financial ratios and other financial tools that can help you achieve your goals, attend one of our upcoming Small Business High Speed Growth Events. Our next event will be held in Anaheim, CA, on July 13, 2011.
I hope you’ll join us. Otherwise, you can visit the Money topic on OPEN Forum® for help keeping up-to-date on business-related money matters.