Are Your Business Accounts Just a Retrospective Scorecard?
As business owners, we all closely track two key financial metrics – turnover (or revenue) and net profit. These are undoubtedly vital indicators of our company’s performance. However, relying solely on these numbers can give us a dangerously incomplete picture. In fact, I’d argue that treating your regular financial statements as the definitive scorecard for your business is a recipe for trouble.
The Problem with the Retrospective Scorecard
Let’s start by taking a closer look at the financial reporting process most small businesses go through. The first step is typically handing off your bookkeeping to someone else – whether that’s a qualified bookkeeper or just someone tasked with tidying up your invoices and receipts. This information then gets fed into an accounting system or a specialized business management software.
From there, the data is packaged up and sent to your accountant, whose primary focus is usually minimizing the amount of tax you owe. Now, I know many accountants do fantastic work, but let’s be honest – if it weren’t for the legal requirement to file annual accounts, would you really be paying for their services?
The key issue here is the significant time lag between the actual activity in your business and when those numbers get reported. By the time your accountant hands you the completed financial statements, those figures are already 6-9 months out of date. That means the “profit” they’re congratulating you on? It’s already been spent.
It’s like finding out the score of a sports game months after it was played – what’s the point? How can you possibly use that information to improve your future performance?
The Same Is True for Your Bookkeeper
Now, you might be thinking, “but I don’t just rely on my accountant – my bookkeeper keeps me up-to-date!” And that’s a fair point. Bookkeepers can certainly provide more timely information than annual accounts.
However, there’s still an inherent lag in the bookkeeping process. Even with a diligent bookkeeper, your profit and loss statements are typically around 21 days behind the actual real-time performance of your business. And don’t forget, there’s always a delay between when you receive goods/services and when you pay for them, as well as the time it takes to process returns and credit notes.
So while your bookkeeper’s reports are better than your annual accounts, they’re still a retrospective scorecard – just a slightly fresher one.
The Limitations of Conventional Financial Statements
Let’s dig a little deeper into the problems with relying on traditional financial statements as your primary business metrics:
1. They’re based on accrual accounting, not cash flow. Accrual accounting is an important legal requirement, but it doesn’t necessarily reflect the actual money moving in and out of your business on a day-to-day basis.
2. They include non-cash items. Things like depreciation and amortization can skew the profitability picture, as they don’t represent actual cash spent.
3. They lack important context. Financial statements alone don’t tell you about customer trends, market conditions, operational issues, or other factors impacting your business.
4. They’re often open to interpretation. Unless you’re an accounting expert, it can be challenging to fully understand what those numbers are really telling you about the health of your company.
In short, your annual accounts and even your bookkeeper’s reports are essentially a retrospective scorecard – a historical record of what’s already happened, not a reliable predictor of what’s to come.
The Power of Cash Flow Forecasting
So if traditional financial statements aren’t enough, what should you be using to measure and manage your business? The answer lies in cash flow forecasting.
A well-constructed cash flow forecast allows you to model different scenarios and predict the future financial health of your company. Instead of just looking in the rearview mirror, you can use this tool to proactively plan for what’s ahead.
Here’s how to build an effective cash flow forecast:
1. Gather all your financial data. Pull together information on sales, expenses, payables, receivables, investments, and any other cash inflows and outflows.
2. Map out your ideal business model. Create a spreadsheet that captures all the financial nuts and bolts of your operation, including both visible and invisible costs.
3. Build multiple scenarios. Don’t just plan for your “best case” – also create forecasts for a “moderate” outcome and a “worst case” situation. This will help you stress-test your business and identify potential pitfalls.
4. Continuously update and refine. Your cash flow forecast shouldn’t be a static document. Review and update it regularly as your business evolves.
The beauty of this approach is that your cash flow forecast gives you a leading indicator, not a retrospective scorecard. Instead of waiting 6-9 months to find out how you did, you can proactively adjust your plans and make informed, data-driven decisions.
For example, let’s say you’re considering hiring a new employee. With a cash flow forecast in place, you can instantly see the financial impact of that decision – will it improve your profitability, or will it put a strain on your cash flow? You’ll know the answer before you even make the hire.
Similarly, if you’re faced with an unexpected event like a major supplier price hike or a sudden drop in sales, your cash flow forecast can help you model the consequences and take swift action to mitigate the impact.
Ditch the Retrospective Scorecard for Good
I know it can be tempting to focus on the vanity metrics like total turnover, but the real key to sustainable business growth lies in understanding and managing your cash flow. Your annual accounts and even your bookkeeper’s reports are just a retrospective scorecard – interesting historical data, but of limited practical use.
Instead, invest the time upfront to build a comprehensive cash flow forecast. It may take some effort to set up, but it will pay dividends in terms of your ability to plan for the future, make smarter decisions, and keep your business financially healthy.
Don’t settle for a retrospective scorecard. Take control of your company’s destiny with a forward-looking cash flow forecast.