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One of the most important things that an entrepreneur can do, is understanding how to read their income statement. Virtual CFO says one of the most impactful things that they can do when they are looking at their income statement, is figure out how many revenue accounts they need to have on their income statement. Many entrepreneurs try to have several, in an effort to be very clear. This ends up backfiring, creating a lot more work for the entrepreneur and increasing the potential for misclassificationís. A good rule of thumb says virtual CFO is having three revenue accounts or less. This way, they can fit all the information on a single page.
The reason why it is important for an income statement to fit on a single page is that so it can be easy to read in order to make good decisions on. The value of the income statement is that it can give and a large amount of information in an easy-to-read format. Entrepreneurs need to read this in order to make big financial decisions like can they make an important asset purchase, can they hire more staff or do they need to lay them off, do they need to change their pricing? Even the largest corporations in the world only have a one-page income statement. Any entrepreneurs that think that their business is unique and needs to have several revenue accounts are probably over classifying things.
Some examples of businesses and the revenue account that they should have our: a restaurant should have one account for food. A restaurant owner might think that they should have a revenue account for dine-in, take out, catering, desserts. However, a restaurant might want to have one for food. Maybe a separate one for if it sells merchandise like T-shirts out of their business. Catering might be a separate one as well, because of the different costs and labour involved. A contractor should have two accounts, one for projects and one for service calls. Medical offices should have one for the doctor’s income, one for the Associate’s income.
Virtual CFO says that when entrepreneurs understand what their income statement should look like, they can minimize the number of accounts they have, so it can be very easy to read. Understanding that can help them use their income statement as a tool efficiently and effectively in their business so that they can make the right decisions financially.
Many entrepreneurs struggle with the operation of their business says virtual CFO because they are not seasoned business owners. They get into business because of their passion for the product or service that they offer, but this does not mean they know how to run a business efficiently or effectively. Because of this, half of all entrepreneurs that open a business in Canada fail. When asked why, 29% of these failed business owners said that the reason why their business failed was that they ran out of cash. Helping entrepreneurs gain financial literacy, can significantly impact the success rate in businesses in Canada.
One Important Way that entrepreneurs can understand their business finances, is by understanding the expenses in their business. For example, many entrepreneurs do not understand the need to differentiate between cost of goods sold and overhead expenses. They consider them all expenses of the business and do not separate them out. Virtual CFO says that this is a huge mistake, because of how different those costs are. For example, the direct costs of the business also known as cost of goods sold fluctuate in the business. The reason why these costs fluctuate, is because they are directly related to the products or services that are sold. If an entrepreneur has a very successful advertising campaign and sees a 50% increase in sales, they need to understand that there costs are also going to go up 50%. This should not be concerning to entrepreneurs, because they should clearly understand that when cost of goods sold goes up, it is because they are making more sales.
Overhead expenses, on the other hand, should not fluctuate says virtual CFO, or at least does not fluctuate very significantly from month-to-month. Overhead costs include things like rent, administration staff, office supplies, and bills like utility bills, phone and Internet. Those costs should all stay relatively the same. An entrepreneur needs to ensure that the price of their products or services, not only cover their direct costs but also cover the overhead expenses of the month. Once they figured that out, that is the minimum amount of money that they need to bring in every single month in order to pay all the expenses that they have, plus pay for the direct costs of producing their product or service.
It is important that entrepreneurs are breaking down their various costs so that they can do this calculation so that they can break even every single month. For example, trades should keep separate categories of expenses like labour, subcontracting and materials. Maybe people wonder why labour and subcontracts are split, but this is so the entrepreneur can specifically see their employees revenue outside of the total labour cost. Physicians, on the other hand, may have one separate expense account for each of their Associates. A dentist may have one account for each of their Associates and one for their hygienists and maybe one for their lab costs for example. Optometrists, will have one for each associate, and instead of the hygienist, the cost of the glasses and contacts.
By understanding how to calculate all of the various expenses of the business, can help entrepreneurs ensure what their breakeven is, so that they can significantly avoid running out of money in their business.
