Archive for May, 2016
Imagine you are in your board room, you’re a startup. You’ve received your initial funding. You’ve got a great idea for a new, break-through, and innovative product. You’ve built a prototype and done an I nitial consumer test. The results are great and now you’re ready to continue building your product to make it ready for market. You are so excited, but all of a sudden your palms start to sweat. Your investors start asking questions about your financial results. “Oh no! What now?” Then they ask the dreaded question, “When will you turn a profit?”. You think, “I’ve just started my company. I haven’t launched my product yet. How can I be profitable when my product’s still in beta testing, my customer base is small, and I have very little revenue?” Then you think “Well, there must be some way we can show a profit”.
This is what I call the danger zone. This is where we may be tempted to create new ways to define standard accounting and business terms. Let’s step back for a moment. What does “profit” really mean? Merriam-Webster defines profit simply as “money that is made in a business, through investing, etc., after all the costs and expenses are paid: a financial gain”. Simple enough. Right? Well, not really. For some businesses, gross profit (revenue less direct selling expenses) is the key measure of profitability. In other businesses, they may look at the “bottom line” which starts with gross profit, then takes into consideration marketing and operating expenses, income taxes and depreciation expense. Still others may look at EBITDA (earnings before interest, taxes, depreciation and amortization) as a measure of profitability. These are all good measurements, but let’s go back to the definition provided us by Merriam-Webster. Profit, is money, or rather income, earned by a business after all expenses and costs are deducted. When discussing “profits” or “profitability” with your investors it is critically important to not only be consistent in your reporting of profits, but to also be open and honest in your communications. To me, this means reporting revenue and expenses in accordance with generally accepted accounting principles. This will most likely not be a reflection of the actual cash you have in your bank account, but you can bet that if you have a positive “bottom line” your bank account will reflect this.
Stay true to yourself, your employees, and your vision. If you’ve got a product or service that is unique in the market and it’s a product that your customers want, then profit will follow. There is no need to “play” with the calculation of profit. It is best to know what your income is and the expenses you incur to develop and deliver your product and run your business.
Susan Nieland, CPA
When you see headlines like “DOW to Drop 80% in 2016” as a small business, startup or early-stage company you may wonder “will my company survive?” Good question. Here’s where your tried and true forecast comes in prepared with the assistance of your trustworthy CPA.
You may think that your company or organization is too small to worry about developing a financial forecast. Dr. Anandi P. Sahu points out in his post on forecasting that the “long-term success of any organization is closely tied to how well management of the organization is able to foresee its future and to develop appropriate strategies to deal with likely future scenarios.” Many business owners, especially owners of small, startup, and early-stage companies, like to use “gut feel” or the “back of the napkin” forecasting approach. Now, there certainly is nothing wrong with these approaches, but they generally don’t provide you with the flexibility needed to meet changing markets and economic conditions. Which is what you need to effectively run your business and grow. Having the right forecasting tool(s) can go a long way to ensuring your success as a business owner and manager.
Ok, so we’ve got to have a forecast. How do we go about doing this? Good question. As I’m sure you are aware, there are various forecasting methodologies that can be used to create your forecast. For these, I’ll refer you to Dr. Sahu’s post on forecasting which is very informative and explains each of the different forecasting methodologies. What I want to bring to light here is the need to have a solid forecasting model, whether this model is Excel-based, or built in a sophisticated forecasting software. The best way, that I have found in my experience, to have a solid financial forecast is to ensure it has these key attributes:
- It follows generally accepted accounting principles (GAAP) as much as practical. This will allow you to compare your actual results to your forecast easily.
- You capture the attributes of the key drivers of your business whether that be inventory turnover, product sales, customer acquisition costs, recurring monthly revenue, revenue per customer, or another meaningful variable that drives profitability and growth.
- It is flexible; you have the ability to change the values of your key drivers so that you can “see” the effect certain decisions may have on your business.
There you have it, your forecast should follow GAAP, capture your key business drivers and be flexible.
Susan Nieland, CPA