Legendary country music songwriter Harlan Howard called what he did "three chords and the truth." That formula might seem overly simple, but Howard found enough complexity in it to pen more than 4,000 songs. One of them, a hit half a century ago, could provide the soundtrack for LBMs' financial reports today: "Heartaches by the Number."
But before you start singing "I Fall To Pieces" (another Howard hit), take a cue and think of all you can do with the three chords you employ in your financial songbook–balance sheet, the income (or profit/loss) statement, and cash flow report. After an era in which analysts say there was too much focus on the P/L, we've reached a time in which all three reports matter. And equally significant, LBM financial experts say, smart dealers are learning to play those chords in ways that reveal stark new truths about their business.
To help you improve your financial picking, here are some expert thoughts regarding what you should be looking for in your financial reports, using a statement by a fictitious chapter S business, Smith Lumber Co., as a guide. We'll follow that with suggested ways to play those numbers.
The Balance Sheet
This measure of what the enterprise owns, what it owes, and what's left over for the owners is the traditional yardstick banks that use to make loans. Given the credit crunch, it's more important than ever to make this one look good. "The banks have more stringent lending rules regulations," financial consultant Chris Rader says. "Before, you could get away with an unhealthy balance sheet. But with the decline of sales in the industry, the balance sheet may be a better indicator today of what a company is worth." Here are some key lines that can cast a shade on your numbers.
|A This covers what you have in cash or can convert into cash within one year.
B Banks are sure to ask: Does this show decreased business or a speedup in how fast your customers are paying?
C Trouble here. Write-offs typically are 0.5% of accounts receivables. These days, you're likely to have a higher amount.
D This traditionally has been a big part of a dealer's assets and justification for getting bank loans. But with the rise of vendor-managed inventory and an increase in custom-orders handling at most places, the value of this number is changing. Lots of dealers measure inventory at historical cost, while others use LIFO–Last In, First Out–to gauge their stock. But beware: There's a push under way to make U.S. accounting rules conform more closely with international standards, and overseas "they do a lot of goofy things," says Craig Loomis, vice president and chief financial officer of Woolf Distributing, Peoria, Ill.
E An increase in depreciation values could be a sign to onlookers that you have old, tired equipment that you're not replacing.
F This area covers what you would have to pay out within a year.
G Is this a traditional bank loan or a balloon payment? The difference can be profound.
H Technically, only the bottom line for assets and liabilities/equity need to balance out. But if your ratio of long-term debt to total capital gets out of whack, the debt-holders can call the tune. Ideally, this number should be zero. In this case, the dealer cut its long-term debt by 17%.
I What's left for the owners after liabilities are subtracted from assets.
Profit/loss statements contain many of the numbers that dealers think about first when they're asked about business. And it is vital. "A balance sheet without a P/L is useless," Rader says. For instance, real estate costs involved in running a business don't show up on a balance sheet, while they do appear in an income statement. Just make sure you're counting everything.
|J If you own the land you're on, do you still charge your business rent for the use of that land? If not, then you're not giving yourself a true picture of your operating expenses. Many owners put their land assets into a separate business and then charge the LBM operation for the use of that dirt.
K What causes this number to change? Lower inventories? New lending terms? A potential investor will ask.
Cash Flow Statement
"You can be profitable and go bankrupt," warned Woolf Distributing's Craig Loomis during an Illinois Lumber and Material Dealers Association seminar in February. "It starts with profit, but doesn't stop there."
That's why the cash flow statement matters. It shows the amount of cash generated–or consumed–over a period of time. Many of the numbers come from the profit/loss statement and balance sheet but are viewed in valuable new ways.
|L From P/L statement.
M These numbers show changes from the previous years. For instance, in receivables, take the accounts receivable outstanding number on the balance sheet and subtract the same number from the year before. In this case, $561,000 minus $525,000 equals $36,000.
N This area covers purchases of buildings, trucks, and major equipment. Hmmm ... No big investments here.
O More comparisons against the previous year. In this case, the dealer has fewer bank loans, but it's also paying less out to the owners.
P Consultants agree that one of the keys for survival in 2009 is making sure you're able to survive off your cash flow. This dealer has more cash on hand now than the year before, and thus needn't go to the bank to make payroll or buy needed goods. Can you say the same?