Small business owners who don't understand their financial statements and don't bother to learn how to read them will never make fully informed decisions for their companies, says Bill Hettinger, co-author of a new book, Finance Without Fear. Hettinger, an economic development and entrepreneurship consultant and business professor, and his co-author, John Dolan-Heitlinger, aim to take the mysteries out of basic financial statements and make them more accessible to entrepreneurs. Once small business owners know what the numbers mean, they can plan more knowledgeably and avoid being blindsided, says Hettinger. Edited excerpts of his recent conversation with Smart Answers columnist Karen E. Klein follow.
Karen E. Klein: Your book contends that most business owners either don't understand the financial details of their companies or don't focus on them. How widespread do you think the problem is?
Bill Hettinger: It seems like 75 percent-ish don't focus on their finances at all. Some of them are artistic people and finance is not the skill they are into. But even the folks who have technical backgrounds don't tend to focus on finances. We find that people wait until they have some external reason to do so, like when they need to go to the bank for a loan, or they need a business plan, or there's some sort of shock to the system.
Someone recently told me: "I'm a sales guy. I didn't have to learn finance until I was 45 and opened my own business." A publicist who worked with me said, "I used to have another business and I never really looked at [finances] until I had to sell the business."
What problems result from that kind of hands-off approach?
On the most basic level, I've talked to entrepreneurs who have no idea how much money their companies make. You shouldn't need to ask your accountant that. If you introduce a new product, you will have no way of determining whether you'll make money off of it. Or you may buy a $25,000 piece of new equipment and you don't figure out until later that you'll never make enough money to pay for it.
Entrepreneurs often discover belatedly that cash isn't income or that their business is not profitable. They take money from their companies before they have to pay for supplies or rent, and three months later they discover they don't have any money to pay taxes.
If the company is successful, does the founder really have to be hands-on about the finances?
The problem is, who's making the day-to-day business decisions? It's probably not the accountant you see quarterly or annually, but you or one of your line managers. It's important that you understand the impact those decisions are having on your bottom line.
Why is there resistance to examining the numbers closely?
We asked this same question when we set out to write [the book]. First, people always gravitate to what their skill set is, so they gravitate toward selling or cooking or whatever—not to numbers.
The other answer we came up with is that finance is complicated. It's usually presented in accountant-speak, not really explained in plain English. We move terminology around in finance. Your accountant may be using different terms, like sales and revenue, which mean the same thing. If you're not in on the language, that becomes very confusing.
Do you advise small business owners to take accounting or other finance courses?
Not necessarily, because accounting is very mechanical and it will be focused on stuff that business owners don't really need to know.
The other thing we discovered: If you have ever looked through a finance book or class, they're all based on manufacturing. So you'll learn about raw material purchases and inventory. They don't talk a lot about service businesses or retail businesses, even though manufacturing only accounts for a third of our economy today.
What do you recommend small business owners do to educate themselves?
You can read five books on small business finances, or take a Kauffman Foundation FastTrac training program, or affiliate with somebody who can provide you with basic financial training. We've got a local nonprofit agency that has put together a series of training programs on business. It's proving really useful to the people who are taking it. When you can make decisions in a peer environment and have discussions about those decisions, that works very well.
What financial documents do you wish business owners could master?
I like to have people focus on a handful of key metrics. Classical accounting goes from the balance sheet to the profit-and-loss statement to the cash-flow statement. I think that's backwards.
Our process is to have entrepreneurs start with their cash-flow statement. Cash is king in a small business, so this is your most important document. Better still, it looks like your checkbook—or it should—and most people are familiar with balancing a checkbook. It will show you whether, at the end of the month, you have money left over after you pay your bills.
We also tell people to focus on their growth rates, which they can pull out of their income statements. Look at your revenues and your expenses from one period to another. If your revenues are growing by 4 percent but expenses are growing by 10 percent, there's a problem.
What other items should business owners be monitoring closely?
We tell people to look at their gross and operating margins so they know how much money they're making on every sale. And look at how much time it takes you to get paid. We advise that everyone take PayPal or use electronic banking so they can speed up the payment process and get their money faster.
How aware should small business owners be of where they fit into the competitive landscape?
All business owners should compare themselves to the rest of their industry, even if they are small businesses playing with large businesses. Believe me, the Gap (GPS) knows what Abercrombie (ANF) and Macy's (M) are doing. But a lot of small coffee shop owners have never looked at what Dunkin Donuts or Starbucks (SBUX) are doing.
In the book, we give data from various sites online about what ballpark margins are for various categories, like food businesses or high-end retail. If you can learn to calculate your own margins, you can compare yourself to these general numbers and it at least gives you something to jump off from. That helps tremendously.
How can successful business owners be so unaware of their standing?
A lot of small business owners are not truly building a business; they're creating jobs for themselves. The definition of a business is making money off of the labor of someone else and creating something that has value beyond yourself.
Very many small businesses don't have a strategy for making a business that can be sold after they're done working at it. They are creating a revenue stream. That's the difference for someone who has put together a profit-and-loss statement and has a balance sheet. At the end of the day, you can take that company down to the bank and expand it or sell it to someone. You can't do that with a revenue stream.