On Target Group Coaching for

Painting Contractors

June 5, 2014

Financial Management

Part 1

Effective Financial Management 3 Financial Indicators

Profits, Cash Flow, ROI Analyzing Your Financial Health Chart of Accounts Tips More Key Performance Indicators

Liquidity, Solvency, Collections, Breakeven

Best Practices: Finance Accounting system is fully & accurately functioning Controls are in place to ensure accuracy A Realistic Workable Profit Plan (aka Budget) is in place Financial Monitoring is being used effectively as a

business tool Key Metrics are being used to keep your finger on the

financial pulse of your business Owner reviews Financial Data and Metrics at least

monthly An adequate credit line is in place Company is profitable, solvent and able to finance its

growth and reward stakeholders

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Sound Financial Management is critical if you wish to: Put together a solid business plan Be in the best position to obtain

financing Grow a sustainable business Create a valuable company that you can

later sell or otherwise provide for your exit from the business

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Effective Financial ManagementKey Financial Data For Business Survival

3 Key Financial Indicators Of Your Business’ State Of HealthBusiness is about making moneyTo do this, it must simultaneously increase

three things: Net profit margin – Operating profit

margin Cash flow Return on investment (ROI)

Indicator 1: Profit Margins Net Profit = What’s left

over after you deduct ALL expenses from the revenue your business generates

Net Profit = Total Income minus Total Expenses

THE bottom line in your business

Indicator of the overall management of the business

Gross Profit = What’s left over after you deduct direct job costs from the revenue your business generates

Gross Profit = Total Income minus Direct Expenses to Produce work

Indicator of the productivity of your production people

Indicator of the accuracy of your estimating and selling

How To Calculate Profit Margins Gross Profit Margin (GP%) is profit derived

from work produced divided by Gross Revenue

Gross Profit Margin = (Gross Profit/Revenue)%

Net Profit Margin (NP%) is after-tax net profit divided by Gross Revenue

Net Profit Margin = (Net Profit/Revenue)%

Improve The Gross Profit Margin by working on the drivers: Production / service delivery processes Material Costs Labor Costs Customer relations Team Skills and Development Pricing & Estimating Selling Skills

Improve the Net Profit Margin by managing: Administrative operating processes Variable Costs Overhead Costs Customer relations Administrative Team Skills and

Development Marketing Activities and Costs

BEST PRACTICE GUIDE : Gross Profit %

Gross Profit Margin = (Gross Profit/Revenue)%

Higher is better – obviously Industry averages are different for

different industriesSet a target based on your budget

BEST PRACTICE GUIDE : Net Operating Profit %**

Net Operating Profit Margin = (Net Operating Profit/Revenue)%

Higher is better 15% is goal (25% BEFORE Owner’s

Compensation) 5% is industry average**Residential and Commercial Contractors under $10MM** There is a distinction between Net Profit and Net

Operating Profit, which is Profit before taxes, and “other” income & expenses not related to operations of the business including financing costs (interest expense)

The three questions of measurement

Is it Accurate? Is it Acceptable Is it Sustainable?

There will be occasions when money is flowing out faster than it is flowing in

Virtually every business experiences times when there is a cash flow gap

Managing cash flow so as to avoid any critical situation due to lack of cash when it is needed is a major responsibility of a business owner

What Does The Cash Flow Cycle Mean To Your Business Operations?

Businesses can make a profit but have negative cash flow

Failing businesses can have positive cash flow, possibly due to large asset sales or collections from past sales

Business start-ups require large cash outlays to build the asset base = cash flow risk

Cash Flow – More Than Just Profit

Over the longer term, you have to manage your cash flow to fund your business growth

You can grow your business in the short term by ‘borrowing’ credit through late payment of suppliers

Eventually, however, everything evens out and such strategies are not sustainable

With that in mind, projected growth should be managed within known cash flow constraints…and if external funds are required, this needs planning in advance

Cash flow Over The Longer Term

Improve Cash Flow Shorten the Cash Flow Cycle Understand the difference between

Cash Flow and Profit Plan in advance for business growth

and/or downturns

BEST PRACTICE GUIDE : Cash Flow Prepare a Cash Flow Projection Manage Your Spending on a monthly, if

not weekly basis Invoice Promptly Develop a systematized approach to

receivables and collections Obtain a line of credit

Indicator 3: Return On Investment Return On Investment is net profit expressed

as a percentage of the value of the total assets you have tied up in the business

ROI = (Net Profit/Total Assets)%

ROI is a profitability ratio – it is the true measure of the financial productivity of a business

BEST PRACTICE GUIDE : ROI

Return on Investment = (Net Profit/Total Assets)%

Higher is betterShould be at least 10%25% or higher is a goal

Characteristics of Financial Health

High tangible net worth (equity) Consistent profitability High cash flow from operations Cash balances representing 30-45 days of operating

expenses AR representing less than 30 days sales A ratio of current assets to current liabilities

(“current ratio”) in excess of 3:1 A high level of working capital A ratio of liabilities to assets of 1.0 or less (debt ratio)

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How do we find out where we stand?

Starts with Financial Statements: Profit & Loss Statement (Income

Statement) Balance Sheet

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Regarding Your Financial Statements… Accuracy is Essential

GIGO Hire Kerry to help you shape up your books

Accrual vs. Cash Basis Accrual Basis – Day to Day operations

Enter Invoices and Bills as they are incurred – not as they are paid

Cash Basis – Paying Tax Enter data on Accrual Basis/Click of a button will

show reports in either format (in QuickBooks)

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Chart of Accounts Tips Good Structure

Sufficient detail to analyze data Use sub accounts where more detail is needed Consider using classes if appropriate

Group Expense accounts appropriately All direct costs in COGS Non Operational Income and Expenses in “Other

Income & Expense” section Group Balance Sheet Liabilities appropriately

Loans that will not be repaid this year in Long Term Liability section

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Profit and Loss StatementIncomeDirect Costs (Cost of Goods Sold)Gross ProfitVariable ExpensesOverhead ExpensesNet Operating ProfitOther Income & ExpensesNet Profit

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Profit and Loss Statement

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Balance SheetDescription

Cash Checking, Savings, Petty CashAccounts Receivable Amounts Due from Customers

Other Current Assets Prepaid Expenses, Amounts due from others

Total Current AssetsFixed Assets Equipment, Vehicles, Property, DepreciationOther Assets Startup expenses, Goodwill from purchase, Company

deposits, Long term loans made to othersTotal Assets

Accounts Payable Amounts owed to VendorsCredit CardsOther Current Liabilities

Payroll Taxes Payable, Customer Deposits, Short Term Lines of Credit

Total Current LiabilitiesLong Term Liabilities Loans, Lines of Credit that will not be paid off in one

yearEquity Contributions, withdrawals, Retained Earnings, Net

IncomeTotal Liabilities & Equity Must equal Total Assets to Balance

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Balance Sheet

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Key Performance Indicators

Factors that indicate the current and future performance of a business in areas that are critical to the company's success.

Revenue to Budget Gross Profit Net Profit Break Even Sales Liquidity - Current Ratio Solvency - Debt Ratio Collections (Days Sales Outstanding)

Financial KPIs

BEST PRACTICE GUIDE : Gross Profit % Gross Profit Margin = (Gross Profit/Revenue)% Higher is better Industry Averages Differ Set a budget target to measure

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BEST PRACTICE GUIDE : Net Operating Profit %** Net Operating Profit Margin = (Net Operating Profit/Revenue)% Higher is better 15% is a goal to shoot for (25% BEFORE

Owner’s Compensation)

** There is a distinction between Net Profit and Net Operating Profit, which is Profit before taxes, and “other” income & expenses not related to operations of the business

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BEST PRACTICE GUIDE : Liquidity Ratios

Current Ratio = Current Assets Current Liabilities

Should be a minimum of 1.5 or higher (3.0 or greater is better)

Quick Ratio = Cash + Equivalents Current Liabilities

Should be at least 1.0Higher is better for both

BEST PRACTICE GUIDE : Debt Ratios

Debt Ratio = Total Liabilities Total Assets

Should be less than 1.0

Debt to Equity Ratio = Long Term Debt Stockholder’s Equity

Should be less than 1.5 or 150%

BEST PRACTICE GUIDE : Days Sales Outstanding (Collections)

Days Sales Outstanding =Accounts Receivable x 365

Annual Revenue (previous 12 months rolling revenue)

Should be 30 days or less

BEST PRACTICE GUIDE : Cash in Bank – Ideal

Cash in Bank = Overhead Expenses* (next month)

Gross Profit MarginPlus: Fixed expenses for months 2 & 3Or – just think 3 months fixed expenses for

a quicker calculation*Include Variable Costs and Overhead Costs

BEST PRACTICE GUIDE : Cash in Bank – Ideal

Cash in Bank = Overhead Expenses* (next month)/Gross Profit

%Plus: Fixed expenses for months 2 & 3

Or – just think 3 months fixed expenses for a quicker calculation

*Include Variable Costs and Overhead Costs

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BEST PRACTICE GUIDE : ROI

Return on Investment = (Net Profit/Total Assets)%

• Higher is better• Should be at least 10%• 25% or higher is a goal

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Implementation Steps Review your own financial statements

and chart of accounts Ask me to review if you would like my

perspective Review your financial goals for 2014 Next Month: We’ll talk about Profit

Planning and creating a budget