As bookkeepers, we often work with businesses that have goals to grow their book of business and seek investors or someday sell to investors. This isn't possible unless every
transaction is tracked and handled a certain way. I'm always amazed at the different mindsets we encounter when talking with business owners. Some treat their business as a hobby and tend to not take it serious while some treat their business very serious and understand it needs to be 100% accurate at all times in order to scale. After talking investors and CFO firms, I've learned that it's always better to be in this ready mindset and not be caught off guard by not being ready to show an investor your books. I've come up with a few areas that all small businesses should focus on if they someday want to present their books to investors.
Owner Draws and Cash Flow
In early start up stages, a small business may not utilize outsourced payroll since the owner or owners are doing all the work. They may pay themselves via Owner Equity Draws and this will result in a much higher profit on the Profit and Loss since it hits the Balance Sheet instead. Before running to an investor to show them your $150,000 profit after 6 months, make sure you are well versed in how payroll and owner draws are handled.
If cash flow is somewhat low, Owner Draws may not be happening at all. This might lead to a
mindset that it's ok to use the company funds for expenses such as food and gas to help get through the bootstrapping period. I've spoke with several investors that can't stand seeing a set of books that reflects the owners using the bank account like a piggy bank. It's best to stay away from this entirely. Making sure this doesn't happen to your business not only shows dedication to getting investors, it also may save you a visit from Uncle Sam.
Having a bookkeeping system that is built to scale appeals to investors. It shows that serious thought and execution has been dedicated to growing the business. Businesses encounter a lot of problems when not being prepared for growth. Knowing when to hire, when to outsource certain tasks, and seek the proper help when needed is very important when the phone starts ringing off the hook and customers want to buy.
Knowing and hitting your margins is another important piece of keeping your books dialed for investors. Knowing your margins starts with having great financial reporting. Being able to pin point the margins on Cost Of Goods Sold based on sales will show that Gross Profit Margin can accurately be forecasted based on historical sales data while combined with budgeting and forecasting trends. Having consistent fixed operating costs will assure that the Net Profit Margin will not fluctuate unexpectedly.
Another margin calculation that may not apply to all businesses is Revenue and Labor Ratios. Maintaining a consistent ratio of revenue to labor can be trickier than it sounds. In the restaurant industry the labor percentages can really have a negative impact on the Profit and Loss if left unchecked. Depending on who you talk to, hitting a ratio or around 20% would be ideal but nearly impossible. A more realistic number may be somewhere between 25%-30%. Being able to hit these numbers and then show and investor this is a powerful tool.
Sometimes a small business owner can have the blinders on and not realize they have the potential to become very profitable and someday seek investors. The best way to be prepared for this is get a great bookkeeping system in place and make sure everything is being executed to its fullest extent. Running a business and putting in a lot of hard work can be stressful and challenging, but it all could pay off someday. Why not be ready for it.