Warren Buffett has famously said that he only needs to make a handful of truly good decisions over long stretches of time to generate extraordinary results. He’s talked about making one great decision every few fives that meaningfully compounds.
The financial version of that is this: you don’t need 100 financial tweaks to transform your business. You just need one hour and one decision per month.
I know it sounds dramatic or overstated, but it’s not. We’ve worked with businesses at Bison CFO where we’ve seen this happen.
Where we’ve spent one meeting mapping their cash conversion cycle and a year later they have a bunch of cash in the bank.
Where we’ve done a pricing model and doubled their profits.
The real problem for most isn’t that you don’t know how to read your financials. It’s that you don’t actually take the time to do so.
So today, I wanted to spend some time going through a “5-Minute Financial Review.”
This is a tool I put together years back, but have found myself coming back to time and again. By doing these high-level financial reviews and then applying the concept of the 5 whys, you can have a massive impact in a short amount of time.
THE 5-MINUTE FINANCIAL REVIEW
Most business owners avoid their financials because they feel heavy, overwhelming, and too technical.
They’re not. If you strip it down, there are really five questions you need to ask every month:
- Are we growing revenue?
- What is our profit margin?
- What is our cash position today?
- What is our future cash need?
- What is our debt load?
REVENUE GROWTH: ARE WE ACTUALLY MOVING FORWARD?
We want to track our trajectory.
This one number can lead to ten other questions and decisions.
We want to compare our growth to:
- Our projections
- Industry expectations
- Sales or upstream metrics
If we’re off from what we expect on any of these, we then need to dig in and figure out why.
WHAT ARE OUR PROFIT MARGINS?
Revenue without margin is vanity. We want to compare our profit margins to the same things we compared our revenue growth to:
- Our projections
- Industry expectations
- Upstream metrics
If costs are rising faster than sales, we find ourselves in a spot where we have slowly eroding margins. That may not seem like something you need to act on today, but we need to notice these small trends so we can move quickly instead of being reactive after it’s already an issue.
WHAT IS OUR CASH POSITION TODAY?
Cash allows flexibility in your decision-making. By having cash, you now have the ability to choose or not choose to take on more debt.
When looking at cash, we want to look at three key numbers:
- Cash balance today: This can be fund on the Balance Sheet or Statement of Cash Flows. Aim to have 2-6 months of operating expenses as a cash balance to sustain a downturn. This will improve your decision-making ability.
- Operating Cash Flow: This is found on the Statement of Cash Flows. Consistent positive OCF is needed to sustain a business over the long-term.
- Free Cash Flow: You might be generating enough money from operations, but if required to reinvest in CapEx, you could still be cash flow negative. FCF tells you this.
Profit tells you if you made money. Cash tells you if you can survive and act.
WHAT UPCOMING CASH NEEDS DO WE HAVE?
This is where most businesses get blindsided. We’re looking for both issues of cash flow and capital needs. This can be:
- CapEx
- Seasonality
- Working Capital swings
You don’t need a perfect forecast, but you do need awareness.
I like to keep a schedule of potential upcoming expenses. Ones that often blindside people are insurance renewals, tax payments, and seasonal swings.
We also want to make sure we have a capital plan and know of the possible replacement cost (both maintenance and new).
WHAT IS OUR DEBT LOAD?
Understanding how much debt you have tells you your ability to pay current and future obligations. Liabilities are broken down into Current (due in < 1 year) and Non-Current. Using different ratios, you can understand the health of the company, as related to debt.
Some good ratios to look at are:
- Debt-to-Equity Ratio = Debt / Equity
- Quick Ratio = (Current Assets − Inventory) / Current Liabilities
- Current Ratio = Current Assets / Current Liabilities
Debt isn’t evil, but unmanaged debt is dangerous. By managing it and understanding the implications, while also understanding upcoming cash needs, you can be more strategic about your debt decisions.
Some good questions to ask:
- Are we adding leverage faster than we’re adding equity?
- Are we comfortably above 1.0 on liquidity ratios?
- Are we using debt strategically or reactively?
Don’t get too caught up on your specific ratios. Instead, understand where you are in relation to the trend and your industry peers. Certain industries are going to carry higher leverage, and that’s okay within that industry context. That’s why you won’t see me giving specific numbers here, as they can be really complex issues.
THE ONE DECISION
We want to bring this home to one decision we’re making each month. Whether that’s pricing, cost structure, cash management, or debt, one specific decision can make all the difference.
You’ll notice I didn’t mention overhead costs here. While we can often find areas in these levers, these should theoretically be managed during our annual planning and budgeting. I like to look at these once per year, but not often more. So on a month-to-month basis, we’re typically looking at actuals versus budget to make sure there aren’t any unexpected expenses.
To further analyze our numbers, I like thinking in the 5 Whys framework. We continue to ask the question “why” until we get to the root cause. So if we see a revenue dip, we want to ask why, and then look at each variable until we get to the actual cause variable.
Asking these five questions above, using the 5 whys to dig deeper, then choosing one change to make… and after six months it’ll feel like magic.
I get it. As an owner, you’re busy. You have a lot of decisions to make and a lot of things vying for your attention. But surely you can devote one hour a month.
We want to stop just reacting to once in front of us and start making true capital allocation decisions and planning for the future. This one hour helps you get into allocation mode instead of reactive mode.
If Buffett can build a fortune on one great decision every five years, you can build a stronger business on 12 good financial decisions a year.
