One of the greatest challenges small business owners face is predicting the future. Insight into trends, spending patterns, and opportunities can help a business move from a reactive mode into a strategic approach that drives growth. However, short of finding a crystal ball that will tell you what’s coming next, how can businesses best predict the future?
Often, the answer lies in studying the company’s own history, especially from a financial perspective, says Jeff Liebel, a partner at business advisory firm Counterpoint Consulting in Williamsville, New York. Yet, few businesses do that. According to the National Federation of Independent Business (NFIB), only about 5 percent of business owners spend most of their time on finances. Liebel says that the time spent on finances is usually focused on the most immediate demands of the business, such as year-end reporting for taxes, collecting receivables, and paying bills and payroll. To help owners dive into the numbers and get a better understanding of their businesses from a financial perspective, Liebel typically has them work on monthly profit and loss reports.
“They need to look at those numbers on a monthly basis and then create a cash budget to understand how the timing of cash is working relative to the cycle of their businesses,” he says.
Once a business can look back on at least two years of data at such a granular level, patterns and trends begin to emerge, Liebel says. By using a few key numbers or metrics, many businesses can predict certain life-cycle events. One of the most important aspects to examine is how seasonal variations in cash usage play out during the course of the year. Many businesses that aren’t traditional “seasonal businesses” still have seasons when they sell more or need to spend more, he says. When a company needs to fulfill large orders, there is a process leading up to that point. It may include investment in inventory, materials or staff to deliver the customers’ orders or service. However, that investment may not be recouped for many months. Many times, businesses will only consider the cash cycle from the time they sell the product until the time they collect their invoice amounts, he says. But expenses come before revenue. When you examine the whole process, it’s possible to reduce the cash-conversion cycle, improve cash flow, and reduce the need for outside financing.
Another important insight that can be gained from examining historical financial data is how to invest capital to best grow the business as well as the most opportune times to do so, says Liebel. Growth opportunities, such as acquiring another business, investing in talent, upgrading equipment, or taking on large, new clients often require significant cash outlay. However, by understanding base operations cost over the past few years, as well as the fluctuations in cash flow and expenses that your business has, you can understand the periods when cash flow is most strained and work on timing expenditures for more flush periods or setting aside cash during those times for opportunities on the horizon.
“It’s important to go back and reconstruct what was going on at the time when you examine the numbers to get the whole picture,” he says. “The most important thing is really identifying your ‘E before R.’ What are all of the expenses you’re expending before you start to see revenue?” When you understand how that dynamic works within your business, you’re better positioned to make informed decisions about your company’s growth, he adds.