September 26, 2013
More Accounting Advice – How to Stay in Business!
2 min read
So, if you’ve got decent financial statements either from an agency automation system, or a third party accountant, how do you know you’re OK? Here are some great rules of thumb, which if you follow them, will keep you out of trouble:
- Pay the company first. Decide up front what your profit margin will be. Organize your income and expenses to generate that amount of revenue. Measure it quarterly. Don’t pay yourself too much money! Make sure the business gets paid first!
- Don’t count bonus or profit sharing money in your profit calculation. What I mean is make your profits assuming you’ll get no bonus or profit sharing. You’ll never go broke. Then use bonus and profit sharing to upgrade your capabilities and grow your business. If you refuse to feed the company it will not feed you.
- Make sure you pay attention to these critical ratios:
The first is the “trust ratio.” Whether or not you are required to have a trust account you should always have enough money to pay insurance companies when due for your customers’ policies. If you maintain 115% of what you owe you will always be in good shape. This is called a 1.15% ratio.
The second is the “current ratio.” This is a ratio of current assets (cash and receivables collectable in 30 days or less) and current liabilities (bills due within 30 days). If you keep a ratio of 125% cash to bills due you will be in good shape.
- A related ratio to the current ratio is the “acid test.” The acid test is generally defined as cash plus current receivables (30 days) over bills due within 30 days. A ratio less than 1 means you are insolvent. What I would add to this for a growth agency is that the acid test should only count cash and ignore receivables. If you do it this way you’ll stay out of trouble.
In my agency, we have looked at these ratios every month for 20 years. We actually look each month at the last five years to monitor trends and anticipate issues. The longer you’re in business the better you can do this.
The last thing I will suggest you do regularly is prepare a Cash Flow Summary or Statement of Cash Flows. You may need accounting help to set this up but it’s very helpful. This statement is just a short illustration of where the cash came from and where it went and how much is left. You can do a budget for this and then monitor performance to budget. Once you set it up its easy and perhaps the most telling and diagnostic tool to help you monitor your business’ health. We have fairly sophisticated financials but this statement only has 14 lines on it. Even I can understand what it’s telling me!
Accounting is boring. And financial statements and ratios are too. But I pay attention to them because they keep me in business. You should too!