(Reprinted with permission, originally featured in Studio Designer, features Caroline Van Wassenhove, CPA.)
You can tell a brocade from a damask with your eyes closed. But when it comes to assessing your business’s long-term health, hazardous blind spots abound. It’s a regrettable reality that designers, like countless other creatives, aren’t necessarily gifted with financial foresight. But proactive planning for the ongoing sustainability of your business is achievable, and it needn’t be painful, either.
Caroline Van Wassenhove, CPA, founder of the Chicago-based firm CVW Accounting and Certified Consultant for Studio Designer, works with residential designers nationwide. “Some of the key indicators that we use include forecasting, profitability ratio analysis, and cash flow analysis,” explains Caroline. Read on for her three financial indicators that can help you determine how viable your design business is.
Forecasting
A fact-based financial forecast can help predict where your business is going. Unlike a budget, which is often infused with your hopes for the business, a forecast undertaken by a pro can help you identify what you can expect to unfold based on your prior and current financial state of affairs and anticipated changes in the market.
“While a budget helps our clients outline the direction they believe their business will take, a forecast provides a clearer indication of what has happened and where the business is likely headed. This helps our clients understand their overall sustainability, which allows them to make timely decisions and adjustments as necessary,” says Caroline. Get started by:
- Assemble historical financial data, including sales, expenses, and cash flow patterns.
- Ask: What are your anticipated sales growth targets for the upcoming quarter (or another period)?
- What are your projected expenses, and how will they change in the forecasted period?
- Are there any external factors or industry trends that might impact your business financially?
Ratio Analysis
Ratio analysis is a financial tool used to evaluate a business’s performance; by dividing figures such as sales, expenses, and profits, you can assess both profitability and efficiency. You’ll also get a clear picture of what’s sustainable for the long haul. It’s a particularly helpful tool for interior design businesses, which can often use a disparate array of billing strategies and have an ever-changing number of incoming and outgoing dollars.
“Through ratio analysis, we help identify our clients’ breakeven point and illustrate the impact their revenue structure — i.e., markup percentage, time billing rates, flat fees, etcetera — and operational expenditures have on their profitability,” says Caroline. Some of the common issues among designers, she says, are mistaking “markup for margins,” and lack of awareness of a project’s true costs. Caroline suggests asking:
- What is your organizational structure? This would include team size and responsibilities, types of projects, number of projects, and location of projects, among other factors.
- “What are your overall business goals? (i.e., paying yourself, increasing profitability, scaling up, paying off debt, working less, etcetera)
- What is your revenue structure? (i.e., markup percentage, time billing rates, flat fees, deposit percentage, etcetera).”
Cash Flow Analysis
Forget about your mouth; put your mind where your money is. Understanding where your cash goes is a basic but oft-overlooked metric for gauging the long-term sustainability of your businesses. How much money do you need to keep the doors open and the lights on? Getting a grip on where you spend and how frequently can help your business remain or become sustainable. Some common costs include taxes, salaries, and other operating expenses; Caroline recommends having funds on hand to cover the equivalent of three months’ worth of expenses.
“Since deposits are typically collected [for design businesses] up front, we help our clients identify how much cash should be reserved for projects, sales tax, income tax, and operational expenditures. Depending on the size of the client and other factors — i.e., accounts receivable ratio — we generally recommend an operational cash reserve of three months of operational expenditures and income taxes, a sales tax cash reserve for any sales tax collected but not yet submitted to the state, and a project cash reserve for any cash collected on a project that is due to the trades,” she explains. Some questions to consider when thinking about cash flow:
- What tools or reports — such as expense trackers and accounting software — are you using to oversee cash flow?
- What reports are you reviewing, and how frequently do you analyze them?
Struggling business owners can get a handle on their current state of affairs by first using the above metrics. Then, targeted responses to business challenges can include:
- Managing cash flow.
- Streamlining a firm’s processes.
- Reducing high-interest debt and spending.
- Speeding up collections.
- Increasing profit margins.
- Allocating resources and personnel more effectively.
As Caroline explains, “Our approach is to first get the account up to date and cleaned up if necessary so we can prepare accurate financial reports for analysis. One of the key reports we focus on is the balance sheet. We note areas of concern or risk regarding such things as liquidity, working capital, and ability to pay off debt.”
Financial planning for the long-term health of your business can be intimidating, but honesty is paramount. After all, when it comes to answering challenging financial questions, “There is no ‘good’ or ‘bad’ answer,” says Caroline. “The sooner we identify the main issues and concerns,” she says, “the sooner we can address them.” The key is prioritizing speed and embracing the courage to tackle any looming threats to your business.
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