Most of us understand how important regular checkups are in preventing big problems from developing down the road. We go to the doctor for our annual physical, visit the dentist twice a year for a cleaning, and get the oil changed in our car every 3,000 miles.
Unfortunately, most business owners neglect to perform regular checkups on their companies. Even those who do perform financial reviews often wait to do so until the end of the year when it is too late to capture potential tax savings or improve that year’s bottom line.
Doing a mid-year checkup of your business allows you to identify potential problems and opportunities…and gives you time to do something about it. Now that summer is here, I want to encourage all business owners to set aside time to take a step back and assess their company’s performance over the first half of the year. This small investment in time can pay huge dividends come December 31 and April 15.
Close the books
In addition to being something a lot of students do the moment summer vacation starts, “closing the books” is also the first step in performing a mid-year checkup of your business. “Closing the books” is an old term used by accountants to describe the process of reconciling all the accounts to ensure every transaction is accounted for and the financial statements are consistent and accurate.
Closing the books on the first six months of the year is an essential part of the mid-year checkup. Your financial statements and accounts provide the data you will use to make sound decisions, and you cannot make good decisions if you don’t have good data to start with.
Here are some questions to ask yourself as you close the books on the first half of year:
- Do the balances as of the last day of the prior year agree with your tax return? If not, ask your tax preparer for the year-end adjustments so you are starting with the correct numbers.
- Are all bank accounts, loans and credit cards up-to-date and reconciled? If not, some expenses might be missing or your income could be under-reported. The reconciliations give you the comfort of knowing that the proper transactions have all been booked.
- Are the accounts receivable and accounts payable accurate? Make sure none of the invoices that are listed in accounts receivable have been paid already. This potential double-counting will distort your income and could cause you to reach inaccurate conclusions about your first-half performance.
- Are your recurring expenses recorded consistently? Many overhead expenses, such as rent, Internet service, and payroll, are the same every month. If your expenses decline significantly from one month to the next, it might be because you have forgotten to record one of these recurring expenses.
Read between the lines
Once you are confident that you have properly closed the books for the first half of the year, you can perform some simple analysis to identify trends and potential problem areas for your company.
Start by comparing your six-month income statement to the previous six months and to the same period from the previous year. Look for large variances between the six-month periods and then spend some time investigating to figure out what accounts for these differences. Did you gain or lose any big clients over those time frames? Did you spend aggressively on advertising, and if so, did your marketing efforts produce a big enough bump in sales to justify the expense.
Some of the most important numbers and ratios to analyze and compare to previous periods include:
- Gross margin: a ratio that shows the percentage of each dollar of revenue that a company keeps as gross profit. This ratio is particularly important for retail businesses.
- Payroll expense/total sales: If this ratio is increasing it means your profit margin is shrinking.
- Average age of accounts receivable: If this number is steadily increasing, you need to start making phone calls to collect on those unpaid invoices. You should also identify any receivables that you deem to be not collectible; it might not be worth your time to try to collect on this revenue.
- Current ratio: short-term debts (e.g., payables, credit cards, lines of credit) as a percentage of current assets (cash and accounts receivable). Again, if this ratio has increased from prior periods, you could be heading into trouble.
It is also important to look at the non-financial numbers such as billable hours, to see if they help in revealing any significant trends in revenue or expenses.
Chart a course for second half
Analyzing the books after the six-month mark helps you get a grasp on how your business is trending for the current year. Now that you are armed with this knowledge, you can proactively set a course for the next six months. Here are some important considerations for your mid-year planning:
- Using the most recent six months as a guide, plot out the rest of the year on a monthly basis. Be sure to account for any seasonality that might occur.
- If business is trending up, you need to decide if you can sustain the growth with your current resources. You might realize that you will need additional staff and more space or equipment to capitalize on the growth opportunities.
- It is never too early to start planning for how to save on taxes. If revenue is up significantly from the previous year, talk to us or your tax preparer so you can identify opportunities to reduce taxable income or defer revenue into the next year.
- If business is trending down, you may need to make some difficult decisions regarding cuts. This is never easy, but you are better off preparing for this now than at the end of the year after you have tapped out your line of credit with the bank. If cash flow is becoming an issue, create a six-month budget and see if you can realistically work out of the hole.
- Determine your monthly or weekly break-even point. This is the point at which sales covers your overhead. Commit this number to memory so you can use it as a quick litmus test to monitor your progress each week or month. You can also convert this number to a non-financial measure, such as billable hours or units sold.
Every business owner should carve out time this summer to give his or her company a mid-year checkup. If you aren’t comfortable doing the financial analysis on your own, summer is typically a slower time for CPAs so they should be available to walk you through the process.
If you have any questions please contact Bart Eilts at 773-525-6171 or bart@eiltscpa.com. I am happy to help you with all or any part of your mid-year checkup.
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