The journey to understanding - Part II
In the first part of this series we looked at the sources of financial data that your business generates, how to see them, and most importantly how to understand some of the errors that are inherent within it. In this post, we'll dive into analyzing your data to understand how you can derive information from it. We'll also touch on the presentation of this information in financial reports.
The haloed ground of information salvation is what you're after. It is what will help you drive higher gross margins, lower your wasted product and drive greater efficiencies out of your workforce. In the end, organization with your data and financial reporting will enable you to not only make more money, but sleep better at night.
Learn more: If wrangling financial reporting for your business keeps you up at night, give us a call at (844) 413-6287.
Managing and understanding your financial data requires a multi-staged approach, with constant process improvement at its heart. The second step is: analyzing your data.
Analyzing data from financial reports
To analyze your financial data you must understand that there is value in the information you'll derive from the data your business produces. Sometimes, however, getting to that information can be very difficult if you don't have the right tools. That's why Focused Energy is here, to help you - for free! We have the Financial Analysis Super Awesome Tool Set P9230498X (I know, it's a mouthful) which anyone can use to start pulling information out of their data.
The first step in analyzing your data is to make sure that your data is going to the correct place (i.e. your chart of accounts). Then, know the important financial reports to understand and how to read the information. The final step is completed by being able to pull that information apart to get to the nuggets of knowledge which helps you transform your decision making.
Once you are able to really understand the financial data that your business produces and the information inherent within it, you can use that knowledge to transform the way you're modeling your business. You can leverage this knowledge to create a more detailed, accurate, and informative financial model, which you can use to help raise money for your business.
Chart of accounts
The first step in analyzing your financial data is to ensure that you have the correct accounts set up to allocate revenues and expenses. The reason you want to ensure your accounts are set up correctly is so that you can pull apart the information and figure out where you're making money, and where you're losing money.
Your revenues should be set up so that they accurately represent the work you're doing for your clients. Each section of your business should have its own revenue line such as services (possibly split by subsections of service work), software as a service (SaaS), etc.
Cost of goods sold (COGS)
As with your revenues, your COGS should be reflective of the costs that it takes to deliver your product, services or software. Be sure you allocate any of your personnel costs, whose work is directly related to your product, as well as delineating between service based and SaaS based COGS.
You should generally split your operating expenses into one of three categories:
1. General and administrative (G&A)
- This category is a bit of a "catch-all." Anything which cannot be allocated to sales and marketing or research and development (R&D) should go here. Some of the following expenses are commonly categorized as G&A:
- Certain dues and subscriptions
- Salaries and payroll taxes
2. Sales and marketing
- This category is related to any expenses directly attributed to your sales and marketing efforts such as:
- Salesforce or other customer relationship management (CRM) tools
3. Research and development (R&D)
- This category is related to any expenses directly attributed to research and development or engineering efforts like:
- Software development
- Engineering dues and subscriptions
- Hosting fees for your development environment
Financial reports and seeing your data
The financial reporting that your business produces is key to being able to make the correct decisions. Every report that you use should be time sequenced by month, so that you can see the amounts and trends properly. Breaking your financial reports out by month will enable you to see if you have properly recognized your revenues and expenses. The reports that you'll be sure you want to understand fully are as follows:
- Profit and loss
- Profit and loss detail
- Balance sheet
- Accounts payable (A/P) detail
- Accounts receivable (A/R) detail
Profit and loss summary (P&L summary)
The profit and loss summary financial report will show you a summary, by month, of each category of revenue and expense that you earned or incurred.
Why it's valuable: You can see where your business is making money, versus where you are spending your cash.
What you should be looking for: You should identify any irregularities or spikes in the numbers which you cannot explain.
How to make it better: Use your operating history (if you have it) to create a budget, by month, to compare your actual spend to what was budgeted. This will help you to quickly see if you're spending more in a certain area than you should be.
Profit and loss detail (P&L detail)
The profit and loss detail report will show you a detailed account of what makes up each number in your P&L, so that you can pull apart your information once it's been analyzed.
Why it's valuable: Your P&L will show you the big number, but the P&L detail will help you to understand what makes that number. Without that information, you won't have any context.
What you should be looking for: You will first need to identify spikes or irregularities in the P&L summary and then use the P&L detail to investigate and explain those discrepancies.
How to make it better: Utilize "classes" in your accounting enterprising resource planning (ERP) to organize your income and expenses. Once you've done that you can use a pivot table in Excel to create a detailed and easy to understand report that organizes your data effectively. This will help you to not only spot trends and discrepancies, but also investigate the detail within that roll.
Balance sheet (Bal. Sht.)
The balance sheet financial report will show you an accounting of your assets, liabilities, and equity. Accounts payable detail (A/P detail) and accounts receivable detail (A/R detail) reports are particularly important.
Why it's valuable: You can use your balance sheet to understand what the current amount of your accounts payable (A/P), accounts receivable (A/R), or other current assets and liabilities are. You will need to regularly review your A/P and A/R reports to ensure that you have a proper accounting of the money you owe, versus the money that is owed to you.
What you should be looking for: Any large unexplained increases or decreases in any account. Pay particular attention to your prepaid expenses and deferred revenues. These should be changing month over month and should not remain static (unless for an explainable reason).
How to make it better: Create a detailed reconciliation of all of your accounts, justifying their month end values. This will greatly help your accountant, and you, to understand how much your company's assets and liabilities are.
Getting the business information
The final piece of analyzing your data is to get the information out of the data your business produces. This is most difficult step of the process.
It requires you to take a step back and see the forest through the trees - which can be quite difficult if you have a lot of other things going on. There are many ways to interpret the information, but looking at your COGS and operating expenses (OpEx) as a percentage of revenue is best. This will make it easy to compare apples to apples. Your COGS should move (generally) in lock step with your revenues, and your OpEx will vary in how they move, based on your unique business challenges.
Trending - absolute (dollar amounts) and relative (percent of income)
The first thing you'll want to do is get take a look at the trends of your revenues, COGS, and general OpEx. Set up a new P&L which makes your COGS and operating expenses a percentage of revenues, and then graph them. Put the months at the bottom and look at how the lines move over time.
Use the trending graphs to direct your efforts in where you look. Are there peaks and valleys that look out of place? If so, dig into the numbers. Are your revenues oddly low or high in another month? Figure out if you didn't accrue your revenues properly, or if you didn't invoice a client. Do your expenses seem really lumpy? If so, there may be a way that you can change your spending to better coincide with your revenues.
Questions to ask
- How do your costs (trending) behave? Are there any large spikes or dips? Why?
- Are your COGS a large percentage of your revenues? Is there any money left over (gross profit) to pay for OpEx?
- How much gross profit do you have left over each month, and does it cover OpEx? Why or why not? Can you reduce your spend in any areas? Can you increase your revenues by increasing your prices?
- Are there ways that you can reduce your COGS – maybe bulk buying? How will this impact your cash flow?
- Are you spending too much on your people? How much revenue per employee do you have? What does it need to be to become profitable and/or cash flow positive?
There are a million and one ways to look at your financial data, but it is incumbent upon you, as the manager, director or owner to own that data. It’s important to understand its intricacies and synthesize what it’s saying so that you can use that information to drive improvements.