Observing finance and accounting professionals – or the way academics at most business schools train them – might lead you to believe that finance and accounting is a complex and arcane language understood only by an initiated few. For an entrepreneur, the truth is that accounting and finance are only tools to accomplish three key tasks:
- To make predictions about the future
- To help you make more effective commitments of time, energy and money to attract customers and deliver goods and services at a larger and more efficient scale; and
- To measure and reassess your progress, so you can reward and encourage profitable behaviors, report progress to third parties, and change directions when necessary.
Aspiring entrepreneurs must learn to grasp accounting and finance tools, rather than merely develop the ability to regurgitate formulas and reproduce financial statements in carefully controlled environments, in order to meet these three objectives.
The First Task: Predictions
One of an entrepreneur’s objectives is to make compelling predictions about the future in a way that attracts others to work on a shared vision that will change the world in some way. A group of people who have a common view of the future can work together to gather assets and to design and create processes that will help attract and satisfy customers in a way that makes the most efficient use of physical resources. In a sense, and within limits, entrepreneurs can shape the needs and desires of customers and transform raw material in a way that changes and shapes reality.
An entrepreneur makes predictions through three basic projections: future revenues, future operating costs, and assets needed to service future demand. Accounting and finance can help because they give us analytical tools to make projections and to link what we expect to happen in the real world with the value added by our efforts.
In the early stages of a venture, projections can unite a team by making a fuzzy vision more concrete, measurable, and actionable. Steps can be broken out so progress can be measured. Quantitative goals can motivate.
In the middle stages of a business, financial statements measure whether earlier predictions were accurate. Trends in sales and costs can be projected into the future. The past results of sales strategies and a measuring of today’s sales leads will make it easier to predict tomorrow’s revenues. Likewise, understanding each step in the supply chain, manufacturing process, and delivery will help predict how costs will change with revenues.
In later stages of a business, if used correctly, financial statements can reduce a complex reality into elegant simplicity, so you can separate noise from what really matters, enabling a large battleship of a company to be turned away from danger.
The Second Task: Making Commitments
Entrepreneurs make commitments in order to build capacity to service future demand and to invest in assets that will lower operating costs. You have to make commitments of time, energy, and money to help design and build sales funnels (processes that attract and close customers) and delivery processes (supply chains, manufacturing processes, or service delivery systems) where a series of steps converts raw materials and labor into something that customers need.
In essence, entrepreneurs make four types of commitments: (1) sunk investments in long-lived or fixed assets like a building or a machine; (2) promises to pay a fixed amount over time to use a fixed asset (rent) or a person’s time (salary); (3) borrowing money to expand; or (4) making working capital investments like inventory or customer credit, that eventually will be sold or recovered.
Costs accounting – measuring costs and relating them to activity – is the key to making good commitments. You must understand the incremental impact to profits and cash flow of every incremental sales, operational, or financial decision.
Cash flow projections and analysis will help you place a value on different commitments so you can weigh one versus another.
The Third Task: Measuring Progress
Using finance and accounting tools to monitor progress and, when necessary, make adjustments is crucial for a business.
First, measuring actual progress versus predicted progress helps to keep you honest. Are you hitting the targets you set?
By accurately measuring results that are tied to individual effort, you can reward top performers. What is measured gets done, and people who know they will be held accountable make better predictions and are more productive.
Measuring progress in a way that links profits and processes helps your business become more productive because it allows you to highlight bottlenecks and problem areas. Tying expenses to those responsible for them and sharing information helps prevent fraud, and also helps you keep investors and employees informed. Transparency leads to more trust and a stronger sense of teamwork.
Finally, measuring progress helps you spot trends in revenues and costs early, so opportunities can be exploited and problems corrected before they pose a real threat to your business.