Math was never one of my favorite subjects in school. In fact, calculus is still a mystery today, but somehow I ended up working in the financial sector. Ironic, right? Or maybe, fate…after all, I love counting money, and the math used in calculating profit/loss, valuations, and margin spreads is very exciting to me.
Some people don’t have the same sentiment, however, and more often than not, these individuals have a small business. I have had countless clients seeking my help in developing operating budgets, program budgets, statements of financial positions, cash flow analysis, and other financial documentation. I cannot stress enough how important it is to know your numbers more intimately when it comes to your business and personal finance.
Sure, you may have a CPA do all that for you, but when you receive your returns, do you know what you’re looking at? Do you know how to reverse calculate to check the numbers to ensure they are right? Because if they’re wrong, you will get audited and you will pay the price, not your accountant.
There are daily calculations in business, such as units sold, profit margins, net gains, etc., etc., etc.
In this post, I want to outline some important calculations for your business success. As always, I advise you seek a professional financial planner, or CPA to assist if you are inexperienced. As a recommendation, if you are using a CPA, ensure that they CERTIFY your returns. This is the guarantee to you, the IRS, and anyone else that these numbers are correct and valid.
I once listened to an Oprah interview where she discovered one of her employees (a bookkeeper) stealing money from her business. Blind-sighted to this, Oprah vowed that she would always from that point know what was going on with the money generated from her business. So, she took a noise dive to learn how to read her own financials and understand the numbers as they related to her business. No one ever stole from her gain.
BASIC MONEY MATH
It’s important to know you numbers, and as equally important is the understanding that these numbers have as it relates to your business or personal finance growth.
Here are some basic calculations that you may be familiar with:
- Net Income – When you calculate your income and substract your expenses.
- Net Profit – When you calculate your net income minus your cost of goods sold.
- Profit Margin – Divide the net income by the sales
Now, let’s say your numbers are looking really great and you have an established pattern of growth for the past 3 years. How do you place a valuation on your company? Unless you were a finance major/minor and specialize in this area, you probably aren’t that familiar with the calculation, or again, you leave it to your CPA to figure it out. Well, that’s all fine, but to restate the obvious….know YOUR numbers.
Giving your company the proper valuation could mean the difference between leaving with a deal from the sharks or going home empty handed. It’s just that important. Too skewed and out of sync with reality will make you look delusional, or worse, that you don’t know enough about the market you’re in.
There are two ratios you will need to establish, the Price-to-Sales Ratio (P/S), and the Price-to-Earnings Ratio (P/E).
The P/S will show how much value is assigned to each dollar of sales within your company. The P/E will compare the annual earnines that a company makes for each share of its stock.
Now, the above is for those who dream of going public with their company one day. It is a primer to learning how to properly evaluate your company when you are “number crunching” for your initial stock price. But, of course, you will have to have a clear picture of all the other numbers above before you can get to the point where this step is being considered.
So, let’s go back to the basics…
- Know your net income
- Know your net profit
- Know your profit margins
In future posts, I’ll be sharing infomation on Balance Sheets, Cash Flow Projections, and Investment Spreads.
Here’s to your remarkable life and legacy!