Josh Aharonoff
Mar 30, 2023
Welcome back to Legit Numbers! (formerly CFO Insights)
In this edition, I'll be sharing a mix of posts that explore critical finance and accounting concepts, including effective management reporting (with template), determining break-even points, understanding the differences between debt and equity, the ins-and-outs of deferred revenue, and analyzing a business with only a balance sheet.
This week Your CFO Guy community loved my posts on:
Management Reporting
Calculate Break Even Point
Debt vs Equity
Everything you need to know about Deferred Revenue
Analyze a business with just a Balance Sheet
Without futher ado, here are the top posts from my LinkedIn!
Every month, it’s crucial to report to management on what’s happening with the business
but if you are just reporting on numbers for the current period...
you are making a BIG mistake
That’s because your financial activity needs CONTEXT…
By Context, I am referring to…
➡️ How did we perform against budget?
This is one of my favorite metrics to report on...
as it showcases how good of a grip you have on what you
THOUGHT was going to happen
➡️ How did we perform against last month?
Every company wants to forecast insane growth…
but it’s rare for that to change so suddenly in the span of 1 month
Comparing your activity this month to what took place last month is a great way to catch any anomalies and take action FAST
➡️ How did we perform against this time last year?
This can be especially relevant for seasonal businesses
and can also be great for any business
The hopes is that your numbers have improved greatly from last year
it’s important to remember where you’ve been as you plan out where you’re going!
When you have all of these metrics at your fingertips, you can make better informed decisions and identify trends / patterns
Here are a few other things to keep in mind:
1️⃣ Showcase your most important KPIs
This is most commonly related to stuff on your P&L, but can also include any other important metrics like your ARR, Cash balance, and whatever else is relevant to your business
2️⃣ Report on both the $$ variance, and the % variance
That’s because without analyzing both of these side by side, the numbers can look misleading
a $1m cash variance when you have $100m in the bank means it was only a 1% miss
3️⃣ Show good variances as positive, and bad variance as negative
This one is personal preference - I’ve seen people also reflect good variance in green, and bad variances in red
Click the GIF image below to download the Management Report template
The Break Even point is a coveted destination for many companies
It’s where your revenue finally matches your costs, and profitability is on the horizon
For most companies, this can be the goal right from day 1
For startups, this can come much further down the line as they start to prepare for an exit
➡️ How do you calculate break even?
This is most commonly expressed using your Revenue, and comparing it to your Fixed Costs and Variable Costs
➡️ What are Fixed costs?
These are costs that don’t scale with each sale.If you are operating a restaurant, a fixed cost may be the rent that you pay each month
➡️ What are Variable costs?
These are the opposite of fixed costs…
IE, they change in proportion to the level of business activity
Back to our example of operating a restaurant, a variable cost may be the cost of materials in the food you are selling
➡️ How do you calculate Break Even?
The formula is rather simple
Break Even Point = Fixed Cost / (Sales price - variable cost)
➡️ Can we go over an example?
🥪 Let’s say you sell sandwiches
🏬 Your rent is $10,000 / month
💰 You charge $10 / sandwich
💸 and your variable costs if $6 / sandwich
The formula would be $10,000 / ($10-$6) = 2,500
That means when you sell 2,500 sandwiches…
You make $10,000 in profit…which is exactly what you need to break even on your fixed costs
🤑🤑🤑
That’s my take on break even
Both can fund your business
But each mean something completely different from the other
Let’s start with some definitions…
➡️ What does it mean to raise Debt?
Raising debt means you received money with the expectation that you will pay back the amount, almost often with interestIt is a liability (since it’s something you owe to a creditor)
and is CAPPED…that is, there is an exact amount that you owe
➡️ What does it mean to raise Equity?
Raising equity is when you receive money, but this time in exchange for ownership in your company
This means that you have a type of liability to the new owner, but this time it’s UNCAPPED…
as it involves giving a share of the profit & loss / sale of the company away
This would show up in the Owner’s Equity section of your balance sheet
➡️ What are the Pros & Cons of raising debt?
Raising debt can be a great way to inject capital into your business if you are comfortable with repaying the amounts with interest
Business owners who are bullish on the future of their business may have no problem raising debt, since they feel confident they will be able to use that capital to generate an even stronger return than what they will pay in interest
The cost of the interest + the schedule in which you agree to repay the loan however may catch up with you, leaving you in a difficult position if things don’t go as planned
➡️ What are the Pros and Cons of raising equity?
Raising equity can often times be a great way to raise capital without having to repay the amounts…
let alone the lack of interest payments
Often times an equity owner will also be a proud contributor to the management of the company, yielding the company both with capital as well as expertise
It can come at a steep cost however, as you no longer have as big of a pie to share in the profits
Equity owners may also get voting rights, ultimately controlling the direction of the company...
which can cause problems if you are not aligned
➡️ When should you raise debt, and when should you raise equity?
While every business is subjective, my 2 cents are:
Raise debt when you feel confident that you have a proven formula for generating a large ROI with the capital, and the interest is low
Raise equity when you feel there is a fair valuation for the company, and you are aligned with the person who wants to become an equity holder in your business
That’s my take on raising debt vs equity
Deferred revenue continues to be where most accountants struggle the most
It can be a real pain to calculate, and an even larger pain to understand 🤕
➡️ What exactly is Deferred Revenue?I’ve seen a lot of definitions for deferred revenue… but I like this one the most:
Deferred Revenue is the $$ amount of goods or service that you currently owe to your customers
That can arise whenever
📄 a contract gets signed…
🧾 An invoice gets sent…
💵 Or cash gets collected…Since it’s something you owe, it’s a liability
➡️ How do you calculate Deferred Revenue?
It’s fairly simple:
Beginning Deferred Revenue
➕Invoices / Cash collected
➖ Revenue recognized🟰
Ending Deferred Revenue
➡️ Can we put it all together in an example?
Say you’re a SaaS startup…and you sell a $12,000 annual license
That triggers Deferred revenue, leaving you with a balance of $12k
After the first month, you would recognize 1/12 in revenue…
And subtract 1/12th from your Deferred Revenue…
Leaving you with a Deferred Revenue balance of $11k
Like this:
Beginning balance: 0
➕new collections / invoices: $12,000
➖revenue recognized this month🟰
ending Deferred Revenue of $11k
That’s my take on Deferred Revenue
Click the image below to be taken to the guide
Analyze a business with just a Balance Sheet 🧐
Most people think all 3 Financial Statements are created equally…
But to me, there’s one statement that is SUPREME to all the others
And that’s the Balance Sheet
➡️ What’s so special about a Balance Sheet?
Perhaps a better way to look at this would be what are the limitations of the other statements…
1️⃣ The Profit and Loss isn’t connected to any other reports
It’s an independent report that show’s you how much you earned in income
and how much you incurred in expenses…
But it leaves you clueless as to what you OWN, and what your obligations are to creditors + owners
2️⃣ The Statement of Cash Flows does not contain any unique data
What do I mean by that?
The Statement of Cash Flows just pulls from your Income Statement and Balance Sheet
It doesn’t show you new information that you can’t find on those 2 statements
and it’s pretty easy to generate on your own
*Note: This is mainly in regards to preparing information using the indirect method, which is the most common
To sum it up…the Balance Sheet contains data from your Profit & Loss…as well as unique data you won’t find elsewhere
➡️ How can you analyze a business with just a Balance Sheet?
A few ways…
1️⃣ Calculate net income by taking the ▲ in Retained Earnings
2️⃣ Create a cash flows statement by taking the ▲ in all balance sheet accounts, other than cash
3️⃣ Analyze key ratios
Here are 5 that you can review
▪️ Current ratio → compares current assets to current liabilities
▪️ Debt to Equity ratio → Compares total debt to shareholders equity
▪️ Return on Assets → Compares net income to total assets (*typo in the guide!)
▪️ Operating Cash Flows ratio → compares operating cash flows to total debt
▪️ Return on Equity → measures net income as a % of shareholders equity
That’s my take on how to analyze a business with just a Balance Sheet
Click the image below to be taken to the guide
That’s it for this weeks edition! I hope you found these posts informative and valuable in your finance and accounting professional journey.
If we haven't connected yet, I'd love to hear from you. Feel free to drop me an email to say hi and share your thoughts on this week's content. I read and respond to each email personally, and I'm always happy to help in any way I can.
Until next time, take care and stay curious!