On the Path to Milk and Honey: How to Read and Love Financial Statements

Fresh-Honey-Ointment What is the difference between great success and financial ruin? Often, very little. But it takes quality financial statements to navigate between the two.

The two main statements are the balance sheet and the income statement. In broad terms, the first shows what you have, while the second shows how you got it.

Confession: I don’t much like the grunt work it takes to produce good statements. Its hard work, and I’ve put it off once or twice. But I love what good statements can do for a company. Thus, I encourage you to stay on it, and include an accountant to help you set them up right. Now back to the story…

 Balance Sheet – This shows all the assets (money and stuff) that your company has to work with at any given point in time. The basic equation for a balance sheet is:

 Assets = Liabilities + Owner Equity

 In other words:

Assets = What the company has today

Liabilities = What the company owes (debt)

Owner Equity = What the company is worth

It goes without saying that a healthy, growing organization gets to see an increase in assets and owner equity from year to year. A particularly savvy one will even eliminate the “liabilities,” making it almost unshakable in adverse conditions.

How do you tell if a company is making progress toward that goal? A big part of the answer to that question is the:

Income Statement – This shows a company’s profitability. It is also referred to as the Profit/Loss Statement. If the balance sheet shows how far you’ve traveled, the income statement shows how fast your motor is turning to get you there.

The income statement is my favorite. It starts at the top with Net Sales for a given period, and then subtracts expenses until the “bottom line” shows profit or loss. Thus, the equation for the income statement is:

Sales – Costs & Expenses = Income 

In other words:

Sales = Everything sold during a given period

Costs = Direct costs of producing products sold

Expenses = Other money spent in the period, like selling expenses and utilities

Income = What’s left over (profit!)

Now let’s sample the magic that comes with good financial statements, using a simple example:

Imagine Farmer Brown sells a case of honey for $14. Without good accounting, he may not know it took $15 to produce it. Obviously he’s losing money on the deal. 

BUT, if Farmer Brown figures out his costs, and can sell it for $16, he makes a $1 profit. (I promised this wasn’t complicated =) If he can sell it for $17, he makes $2 profit (double!) on each sale.

If Farmer Brown’s miscellaneous expenses are $20,000, he needs to sell 10,000 cases at $17 to break even. If he increases the price to $18, he makes $3 per case, resulting in a $10,000 profit on 10,000 cases after covering the $20,000 in expenses.

In this case, what’s the difference between great success and financial ruin? About $4.  




The Myth of Overnight Success

I recently read an article by a popular blogger in a reputable magazine on “How to become an overnight success.”  The premise was that it once took years to become a success.  Now, according to the article, a new product or service can become a success overnight.  This writer is in good company; there is a blog on every corner with a guide to instant fame and riches.

I was appalled by the article.  So appalled, in fact, that I confronted the man about it.  While I agree that ideas travel faster in our world of technology, I think his premise is a lie.  Let me explain.

If I shoot a great cat video, it can go viral. My video may spread across the internet in a matter of days.  But does that make me a “success?”  I don’t think so.  Does it create a lasting brand?  Of course not.  Even if I create an app and sell it to Google, and make a lot of money, does that make me a success?  I don’t really think so!  (Nor is anything worth Google’s attention created “overnight.”)   

The truth is that it takes sweat and blood to build a lasting company, brand, or anything else deserving the title “success.”   The danger of spreading the instant-success-myth is that it discourages people.  “What if I’m not a success overnight?  What did I do wrong?”  Nothing!  Nobody is a success overnight!  Ask any recipient of a lifetime achievement award in any industry, and he or she will tell you some version of what Dave Ramsey says about his company Lampo Group:  “We spent 20 years in the trenches, and THEN we became an overnight success.”  Any other outlook on life will only end in tears.  



The Lean Startup

I’ve been wrestling with a topic this week. The idea comes from Eric Ries in his excellent book The Lean Startup.  Ries’ idea goes as follows (my paraphrase):  Any new company is wise to launch with an MVP (Minimum Viable Product.)  The MVP is an incomplete product with errors.  It is just good enough to see if an idea gets a warm welcome in the market.  After the market accepts it, the entrepreneur should begin tests to improve it, based on empirical data.

If you have an entrepreneurial spirit, I imagine the idea of an incomplete, buggy prototype hitting customers will bother you also.  Every entrepreneur dreams of walking on the stage with “the perfect product.”  The crowd goes wild, and sales skyrocket, because the entrepreneur and the team did such a great job researching the market.  That’s the way the story is supposed to go.

But Ries says those stories are fairytales.  When they happen, they are all over the news.  But they are one in a million, and they mislead the rest of us.  He suggests that there is no such thing as good market research (or else fewer companies would go wrong after spending a fortune on it), and the only real way to see if an idea floats is to put it in the water.  He also suggests that customers, especially early adopters, will forgive the product that wasn’t finished when they first saw it.  And they will be happy (even proud) to help improve it.  

I appreciate his logic in my mind, but haven’t yet embraced it in my heart.  His argument is compelling.  His list of companies that grow this way is impressive.  But it seems so clumsy, and why not just get it right before you go to market?  

I think Ries would suggest that “right” is a big question mark.  In an example, he shares how his team once cut a huge corner in programing an avatar (apparently a small figure that travels across a computer screen) to jump to a mouse-click instead of walking dramatically across the screen like those from the competitors.  His team knew it was hokey, and their peers likely laughed behind their backs.  But customers didn’t know it was a programming shortcut, and they loved it.  The overwhelming response was that the new “click” innovation made the avatar better than the competition.

I do find some peace in the MVP concept.  The idea, embraced, would say that launching beef with uninspired packaging, a mowing company without a logo, or a tasting room with not-yet-done landscaping, is a fine approach.  Even better, it is the recommended strategy by one of the finest minds from Silicon Valley.  If only I had known that all along =)  



What’s Your Problem?

Here’s a small secret of business: You need a problem. To be more clear, somebody ELSE needs a problem, and the purpose of your business is to solve it.

One of my first business ventures was a lawn mowing company that I started in college. The business plan was very simple: I bought a mower, borrowed a trailer and leased a garage in exchange for mowing the lawn in front of it. Then I printed fliers advertising my services, and distributed them to mailboxes in the fanciest neighborhood in town. This seemed like a good plan, until a wealthy-looking fellow in a Dodge Viper pulled up to my parked Jeep to give me a little insider info: “The homeowners association mows our lawns, son. You’re wasting your time.”

In that neighborhood, there was no problem to be solved. They already had a GOOD mowing solution, and it even happened to be free.

A problem can be local, like a lack of decent Mexican restaurants in small-town, Kansas. Or a problem can be much larger, like a lack organic wine grapes in Northern California. But if there is no need for a better (or first) Mexican restaurant, or no need for more grapes, there’s no reason to build a business that provides either of those things.

I’m surprised at how often this “secret” gets ignored. How often do you see a new restaurant, surrounded by other restaurants, close in 6 months? Was there a need for another restaurant? There may have been, if the others were poorly run. Otherwise, a new restaurateur is wasting his time. (Also, he should start with enough cash to survive more than 6 months without revenue, but that’s a blog for another day.)

Brewing beer or making pizza is a hobby, if it doesn’t solve a problem. If I start a brewery because I like to brew, but nobody has a lack of excellent beer, it won’t be much of a business.

Some of the best companies in the world solve problems people never knew they had, like Henry Ford’s Model T (horses were too slow), Apple Computer’s iPod (MP3 player’s were awkward and bulky), and Garmin’s Vivofit (fitness bands had terrible battery life and limited water resistance.)

Fortunately, there are plenty of problems to be solved, needs to fill and variations of existing solutions to invent. For every one neighborhood that doesn’t need a better lawn service, there are 10 others that do.