Use more than one metric

The company my friends and I started five months ago is finally showing a profit. You’d think we’d be thrilled–and we are, but only cautiously so. Our monthly profit-and-loss sheet is looking fairly good. Our income is exceeding our expenses.

The problem is that our bank account continues to shrink. One of the most important lessons in accounting is to know what each of the standard accounting reports really show. Our profit-and-loss sheet may show a profit, but that’s not the entire story. It doesn’t look at cash flow. And the truth is, we are still spending more every month than we take in.

The reason is that we are still increasing our inventory. The purchase of inventory doesn’t figure into the profit-and-loss report. We are taking cash–an asset–and turning it into inventory–another asset. The profit-and-loss (or P and L) is only looking to see how much you sold, how much those goods cost to sell, and what other expenses you had during the period. If your sales minus cost of goods and expenses is greater than zero, congratulations! You’re profitable!

Unfortunately, you need cash to run a business. In most cases you can’t pay your bills with inventory. So any time you convert cash to inventory, that’s cash you can’t use to pay expenses. If you don’t balance your acquisition of assets with your inflow of cash your business can end up in serious trouble–starving in the midst of plenty.

So we’re pleased that our P and L shows our income is exceeding our expenses. But we don’t rely on just that one metric to measure the health of our business. Coupled with the Cash Flow report, we get a clearer picture. Our business is indeed growing, but we know we still need to get our spending under control before we are truly on solid ground.

Never rely on just one metric in your business. Make sure you have as many as you need to help you understand what is going on within your business (we currently use at least five different metrics). While it is possible to measure too much in a business, I suspect very, very few businesses ever come close to having that problem. Multiple measurements are key.

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