Building a Business vs. Making a Living

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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.

Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.