For my wife’s and my 25th wedding anniversary, our family went to France. Paris, Provence, Chamonix and on the way back to Paris to catch our flight home, we went to the cathedral in Reims. The one with the Chagall stained glass and where Joan of Arc was to be crowned by King Charles in 1429 after her victory in Orleans in the 100 Years War. On the drive back to Paris, I was a little uncertain about directions so I pulled into a gas station to ask. By the way, none of us spoke French. But, in the best French I could muster I said, “Parlez-vous anglaise?”. The owner’s reply was to spit at the floor and give me a look that sent me quickly on my way. How dare I come to his country and not speak his language.
Just like trying to speak the language in a foreign country, if you’re trying to run a business but you don’t speak the language, how do you know you’re headed in the right direction? You have two choices: either learn the language or get someone to interpret. Business owners are experts at their craft, but they are not always well-versed in the language of accounting or financial management.
An introduction to the language of business (accounting) starts with terms like profitability, activity, liquidity, and leverage.
- Profitability: How much money are you making? Gross profit is before operating expenses and net profit is after.
- Activity: How are you collecting your receivables? This is expressed as either a turn or in days. Sales annualized divided by accounts receivable = turn, 360 days divided by turn = AR in days. Cost of goods sold annualized divided by inventory = inventory turn, 360 divided by turn = inventory in days. Generally, the faster you can turn these the better. Why? Because the turn is into cash and cash is king!
- Liquidity: How much cash do you have in the bank? I like to use the number of days sales you have in cash as a rule of thumb. Sales divided by number of days to date (March 31 is 90 days) = sales per day, Cash divided by sales per day = days sales in cash. 15 days or more is good for starters. Other people like to use working capital to determine liquidity, which is current assets minus current liabilities.
- Leverage: How much of your money do you have in the business vs. how much of your creditors’ money? Total debt divided by total net worth = your leverage. $3 debt to $1 of equity is probably the maximum you should have. There are always exceptions.
Learning these terms and what they mean is the equivalent of saying “good morning”, “please/thank you”, or “do you speak English?” in a foreign language. Once you’ve mastered the basics, it’s time to move on to more intermediate and advanced classes. Don’t make the same mistake I did by going to France without learning the language. Learn the language of business so that, in time, you can become fluent in accounting and begin realizing the business of your dreams.