When business owners need to cut costs one of the first expenses they consider are salaries. But reducing your staff size isn’t always the best answer even though it can create immediate cash savings. Below is an interview with Eric of Gnosis Arts who decided to increase prices as a way to generate more cash flow. Was he crazy to do this in a down economy?

Me: A few months ago you made a decision to increase your prices and ramp up your marketing efforts. You did both of these things in a down economy in hopes of increasing sales and preventing layoffs. Most business can probably understand the logic of increasing marking efforts, but increasing prices, that was a very strategic decision. What steps did you take to implement those changes and how quickly did you see results?

Eric at Gnosis Arts: First we had a meeting with key staff to come up with a new pricing level. (The Business Development Manager, PR Manager, COO, and myself). We listened to each others arguments for or against.

Second, I trusted the judgment of Suzan Pleva, the business development manager. She has a background in sales. It was her idea to raise prices. She comes from a sales background, so her main argument was: “Listen, we have an excellent service, we dominate the market for it (Wikipedia writing services) – we can charge much higher for this and I believe customers will pay it because I believe in the service and I believe that I can convince them to believe in us.” Going through this process, I found that sometimes just doing market research and trying to figure out what the market will bear can leave you shortsighted.

Finally, we did some research and found that top freelance writers, e.g., those that wrote for pubs like the NY Times, etc – were commanding close to $100/hr for their writing services. We were initially charging $36. We felt it we had paid our dues, so to speak, and had delivered an outstanding service to many clients. In addition, we can arguable be considered authorities in the field of technical online writing – so we raised rates to $70/hr and we felt this was fair pricing for our customers.

Me: In the NYtimes.com video you mentioned that sometimes you have to take risks in order to find the reward. Other than your recent business decision to increase prices and marketing efforts, what risks have you taken in your business?

Eric at Gnosis Arts: Well, it was a risk to keep our two main staff – Suzan Pleva and Susan Marie Kovalinsky, even though we didn’t fully see how we were going to justify their wages. And I think anytime you hire someone, you take a bit of a risk. I’ve hired several people who turned out to cost the firm money in the end, and so I had to let them go. I think the key for an entrepreneur is not to take no risks at all, but to take calculated risks.

Me: Do you use your financial data to make decisions? If so, what data do you use? How does it help you make decisions in your business?

Eric at Gnosis Arts: I mainly use the P & L statement to make decisions. It tells me where we might be spending too much on certain services. It also shows me precisely how much we’re spending on staff wages – typically this will be your largest expense. Knowing that helps me with sales forecasting.

I am also a big proponent of using CPA (Cost Per Acquisition). We track our advertising spend and compare it with sales generated to determine the CPA ratio. For example, if I know that it costs $37 in ad spend to generate 1 Wikipedia customer, I can use this data to try to come up with creative ways to reduce that dollar amount. This type of information determines where we will advertise, which ad services we will use, and how much we will spend on advertising in a given month.

Me: What is one mistake business owners make when consider an online marketing strategy?

Eric at Gnosis Arts: One of the biggest mistakes is not getting your tracking right from the beginning. You need to be able to evaluate the effectiveness of a particular online marketing channel in terms of generating leads and sales. Without proper tracking mechanism, detailed web analytics, it is difficult to measure this.

Another mistake I see a lot is focusing too much on only one or two online channels. For example, some people only do social media. Others only do organic SEO. But to be really effective, an online marketing strategy should utilize several online channels, and try to create a synergy among them: email, PPC, online PR, mobile, social media, B2B/B2C freelance sites (e.g., craigslist, elance), etc.

A third common mistake is mistaking correlational data for causal data. For example, we consulted with a novelist who swore up and down that she generates tons of book sales from using Twitter alone. After drilling down into it a little deeper, however, the truth was only that people were purchasing her books elsewhere, and then later found her on twitter and commented that they liked this or that book. She was mistaking this for “Twitter generating the sales.” Though this is a simple example, there are many variations on this theme.

Me: What prompted you to start Gnosis Arts?

Originally, I had no intention of starting a business. I was just following after the things I was passionate about and enjoyed: Internet marketing, writing, music, multimedia. After it became apparent that I offered services that people really wanted and needed, I began seriously thinking about making Gnosis Arts a legitimate, profitable business in 2007. I suppose I wanted to do it, mainly just to see if I could. I didn’t even really think much about profit or prices. When I first began, we used to sell some services for $5! It gave me such a thrill, conceiving a service, doing market research, SEO-ing my website, negotiating a deal – that I decided to make it a business.

Me: Describe the services offered by Gnosis Arts.

Eric at Gnosis Arts:
Writing & Communications
• Wikipedia Writing
• Article Marketing
• News & Press Releases
• Writing Research Tools

Multimedia Web Promotion
• Audio/Video Web Applications
• Upload Photos/Videos
• Mobile Website Conversion
• Mobile Applications
• Chat Box Deployment

Internet Marketing
• Search Engine Optimization
• Submit A Free Press Release
• Get Our Latest Social Media Marketing eBook
• NEW! Twtsynd: Twitter Syndication Network

To learn more about Gnosis Arts visit their website. Follow Eric on Twitter at: @slashcareer.
To be considered for a Small Business Owner interview, please leave a comment on this post.

Every time I teach an Intro to Financial Accounting course my students get lost on the concepts of debits and credits. For many of the students this is their first foray into accounting outside of their debit cards. They view debits and credits as negative and positive, respectively.

The words debit and credit have Latin roots, but simply mean left side and right side. Investopedia has a short explanation on the history of debits and credits.

Consider the debit and credit terminology as we use for our bank/investment accounts, debit cards and credit cards. When we make a deposit, i.e., credit, into our bank account we know that we have money in our account. However, from the banks perspective they have a liability. At some point the bank knows we will withdraw that money because it is rightfully ours. Using the same principles, when we make a purchase via a debit card or check we are taking money out of our account. The bank no longer “owes” us that money because they just “paid” it back to us through our use of the funds. The bank is using the correct accounting terminology from their perspective. However, it has really confused the everyday citizen about what debits and credits mean and how they are used in accounting.

Debits and credits are used to record business transactions. These transactions are recorded using a double-entry system which helps ensure the accuracy of the information and prevention of errors. While it is not a perfect system, it works most of the time.

It is not necessary to understand debits and credits in order to use your financial data. It is more important to understand the types of accounts used in your business and what transactions increase or decrease those accounts. Knowing why your profits are up or down is really where your energies should be focused.

With my blog I am trying to convince business owners to use their accounting data to make business decisions. There are many reasons to use you accounting information on a regular basis, preferably monthly. In addition, there are many different ways to use the data.

Accounting data can be used to:
1. Determine how liquid your business is. By calculating a few ratios you can determine if you have enough current assets to pay your current debts. This is particularly important if you have one or more customers who are slow to pay you and you are anxiously awaiting their payments.

2. Assess your long-term solvency. Solvency is the ability to pay your long-term debts. If you are short on cash, will you be able to pay your long-term obligations? Even if you have good cash flow today, is there any possibility this may change? We need to think long-term so that our business can continue to operate effectively.

3. Provide a snap shot of how well, i.e., efficiently, your business is running. The income statement is a good place to see how well, or poorly, operations are generating revenues and managing expenses.

4. Obtain outside financing. A banker or investor will want to review your financial statements and perform their own analysis on the numbers. Your ability to obtain financing will be based on those results.

5. Make purchasing decisions, such as a new truck or equipment, or other business decisions such as moving to a bigger (or smaller) location.

The information reported on the balance sheet and income statement are truly a wealth of knowledge. Many people use the phrase “numbers don’t lie.” These numbers, if used and analyzed on a regular basis, will help you create a very effective and efficient business. In trying economic times, the regular use of your accounting data will prove beneficial for the long-term success of your business.

In my last blog post we discussed why you should read and analyze your Balance Sheet. Now we’ll discuss how to use it in your business.

Each month you should compare your current Balance Sheet to the prior month and to the prior year the same month. How does the current Balance Sheet compare? Hopefully you have less debt this month than you did last month or last year. Did you add new assets? If so, how have those assets contributed to your revenue (you’ll have to analyze the Income Statement to answer this question)?

So what information does the Balance Sheet provide? Here are a few of my favorite Balance Sheet ratios with a description of the knowledge gained from the results:

1. Current Ratio. Determined by taking your current assets divided by current liabilities. You want a ratio of at least 1:1 or better. This ratio measures your ability to convert your current (short term) assets into cash to pay your current (short term) debt. Generally, a ratio of 1:1 isn’t going to give you enough cash to pay your debts so you want to strive for a 2:1 or better.

2. Receivables Turnover ratio. Compare your net credit sales to your accounts receivables by taking Net Credit Sales divided by Average Net Receivables. The result will give you the number of times per year you collect your accounts receivables. For example, if the result of the formula is 6 then you are collecting your receivables about once every 60 days.

3. Average Collection Period. Convert your Receivables Turnover ratio into days outstanding by taking 365 and dividing by the Receivables Turnover ratio result. Assume your Receivables Turnover was 12; we would then get 30.4 days your receivables are outstanding (ratio: 365/12).

4. Debt to Total Assets ratio. If you needed to convert your assets into cash to pay your long-term debts, would you have enough to cover your outstanding balances? The Debt to Assets ratio will tell you. To determine the proportion of debts to assets take your Total Liabilities divided by Total Assets.

Perform an analysis on your Balance Sheet for the current month. Then do the same for the prior month and the same month the prior year. What do the trends look like? What information have you gained from this analysis?

How often do you review your Balance Sheet? Is it monthly, quarterly, yearly or never? The Balance Sheet is the ugly stepsister to the Income Statement. Every business owner wants to know how much money they have in the bank. They may even review the Income Statement and perform ratio analysis to gain more information about the past month. But few will do any review or analysis on the Balance Sheet.

For a small business the Balance Sheet may not change much from month to month. However, checking the balances weekly or monthly for accounts receivable and accounts payable is a good practice. Determine how much of your accounts receivable balance is over 30 days old. What can you do to get your customers to pay within the next 10 days? Do you have any outstanding balances to your vendors that exceed 30 days? If so, will they be willing to continue to do business with you until the balance is paid?

The Balance Sheet can give you a snapshot of the overall business health. Do you own more in assets than you have in debt? If not, then you should consider what tactical, i.e., short term, actions you can take to reverse this trend. Are you liquid enough that you could pay your short-term debts, if necessary? What about your long-term solvency? Will you be able to service the long-term debt sitting on your books? Or should you contact your bank to negotiate a lower interest rate or extended payback period?

The information on the Balance Sheet is fairly logical and intuitive, which is probably why it gets overlooked as a financial tool for internal users. Consider how a banker might view the information on your Balance Sheet. Would you be willing to loan money to you? Do some analysis on the Balance Sheet to answer that question and then make a list of five things you can do to improve your company’s financial position.

Once you have the Income Statement prepared, see The Income Statement: How to Read it post, it is time to compare your results from the current month to the prior month. Using the same logic, compare your current results to the same month of the prior year. In what areas did your business improve? What areas didn’t do as well?

First compare the prior month and same month the prior year by looking at the gross dollar amounts. You can gain some basic information about how your business is doing. While the dollar figures provide some information as to what areas to focus on in the future, it is helpful to convert some of this information into percentages to get a more accurate picture. For example, let’s assume that your Gross Revenues decreased slightly from May to June. It should follow that your Cost of Goods Sold decrease too. Assume that in May the Gross Margin was 60% but in June it was only 55%. What happened? Did your vendors increase their costs? Or did you sell your products at a discount in order to generate more sales? What is the trend in the Gross Margin over 6 months? Over 3 years?

There are many other ratios you can use to evaluate your business using the Income Statement. Since every business is different there is not one ratio that is necessarily more important than the others. Two of my favorites are:

1. Receivables Turnover (Net Credit Sales/Average Net Receivables) – provides the number of times per year that you are collecting your outstanding Accounts Receivables. You can convert this into days using the following formula: (365/Receivables Turnover ratio)=days.*

2. Profit Margin ratio (Net Income/Net Sales) – provides the rate of the conversion of sales into profits.

It is important to monitor the balance of cash in your checking account. However, a review and ratio analysis of the Income Statement will help determine how effective you and your business have been generating and using cash.

*Note, the Receivables Turnover ratio includes an item, average Net Receivables, from the Balance Sheet.

Many business owners follow the motto that “cash is king.” And while cash is extremely important, the ending balance in your bank account does not tell you much about how you generated or used cash. Looking only at your cash balance may cause you to miss some key indicators on how your business is doing. The Income Statement is full of useful information about how the cash is flowing into and out of your business.

When reading an Income Statement start at the top, see a summarized Income Statement below. Gross Revenue is the first line item on the Income Statement. Gross Revenue is the accumulation of your sales. You can review your Income Statement monthly (required), weekly or even daily (depending on the accuracy of daily recording keeping).

If you own a business that sells products, i.e., you have inventory, you should have the line item Cost of Goods Sold. Cost of Goods Sold is the expense associated with the products you sold. You would have purchased these inventory items to sell in your wholesale/retail or online stores. Once these inventory items are sold you convert the asset into an expense, i.e., Cost of Goods Sold. If you have a service business you may report direct costs in the Cost of Sales account.

The Gross Profit is determine by subtracting the Cost of Goods Sold (or Cost of Sales) from the Gross Revenues. The Gross Profit is the amount of “money” you have left over to pay for operating expenses such as rent, utilities, staff salaries, insurance, phone, etc.

After you calculate the Gross Profit, you need to subtract the Operating Expenses. Operating expenses are the indirect cost incurred to run the business, such as rent, utilities, phone, and marketing expenses.

The last line on the Income statement will be the Net Profit. Hopefully this line item is a positive number. The Net Profit tells you how much “profit” you have per every dollar in Gross Sales. This is not necessarily your cash profit, especially if you had depreciation or made large purchases of equipment during the period.

Summarized Income Statement

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What does your cash flow look like right now? Are you still worried about the economy? Have you been putting off purchases or hiring a new employee because cash is a little tight? What about that new computer you need because the one you are using is 2-3 years old?

A friend of mine recently told me he has become a cash buyer. If he doesn’t have the cash, he doesn’t buy. In my personal life I follow this logic, to some extent. Our home is financed as is one of our cars, but everything else is paid for in full at the time of purchase. My husband and I are both simple people so this work for us. However, this might not work for you in your personal life, but can it work for your business?

What would happen in your business if you only made purchases when you had the cash to do so? Note, we are talking about big purchases, not your daily operational costs associated with inventory or supplies to provide your products or services. Would your manufacturing process suffer because you don’t have the most modern equipment? Can you get by with the computer equipment you current have?

We have all heard the saying that you have to spend money to make money. And while this saying does make sense, especially for advertising and outsourcing, we should strategically plan for how we use our cash. Incurring debt to buy a new laptop creates additional burdens on the business owner for how they manage the cash available for daily operations or emergencies.

I challenge you to only make purchases when you have the cash on hand for one month. Can you do it? If so, does the “cash only” negatively or positively impact your gross sales? If your sales are not negatively impacted, could you use this strategy for one more month? What changes do you notice in your bank account? To your stress levels?

Share your story here.

Gross profit and profit margin sound very similar, yet they are very different and serve distinct purposes for analyzing your business.

Gross profit is found by taking the net sales minus the cost of goods sold. For example, to find gross profit, a dressmaker make add up all of the receipts for the dresses sold, then subtract the cost of the fabric, thread, thimbles, the wages paid to a junior dressmaker who helped sew the dresses. The result is the amount of profit made only considering direct costs, i.e., gross profit. To convert the dollar amount into a percentage, take the gross profit divided by net sales, and multiplying by 100. While you can compare your result to other companies in your industry, it is generally difficult to accurately compare across companies using this calculation, so this is often done as an internal measure to see how the business is doing from year to year. Compare this ratio to the same month of the prior year or the previous month to spot any significant trends.

Net profit are the earnings remaining after you have accounted for all expenses, including depreciation and taxes. Net profit margin is found by taking the net profits (which is the profit after taxes have been paid) divided by revenue, multiplied by 100. Net profit can be used to compare your results to other companies within your industry. Since all items have been accounted in calculating the net profit margin, it allows for more comparability to the industry standard or your competitors.

Ratios provide a great means for measuring and monitoring business performance. These are just two of the many ratios that might be applicable to your business.

Financing is typically divided into two different categories, Debt Financing and Equity Financing. Understanding the different financing options is a critical step in a company’s financial planning strategy. Debt Financing involves borrowing money that will be paid back over time. The debt can be short term (less than one year) or long term (more than one year). The only obligation to the lender is the repayment of the loan. Equity financing involves the receipt of funding in exchange for ownership shares in the company. The “borrowing” company does not incur additional debt and thus will not have to repay the loan amount.

There are several advantages and disadvantages to debt financing and maintaining an appropriate debt-to-equity ratio is essential for securing future financing as well as for long term financial health. Financial experts cite numerous advantages to Debt Financing. One of the main advantages is that debt financing provides funding without diluting the ownership of the company. Additionally, with debt financing, lenders do not have a claim on any future profits of the company; the lender is limited to receiving an amount equal to the loan principal plus interest.  Most business owners find that raising capital from debt financing is much easier than equity financing as business owners do not have to comply with state and federal securities regulations. Debt financing also provides tax benefits in that the interest paid to service the debt is tax deductible.

Companies often find that there are disadvantages to debt financing. One of the obvious disadvantages is that funds financed through debt must eventually be paid back. In debt financing the principal and interest payments become fixed costs that must be accounted for when a company is determining its break-even point. Although debt payments occur on a fixed schedule, the payments require careful budgeting of cash flow which can be difficult for new businesses or business with highly varying business cycles. Debt financing also negatively affects the company’s debt-to-equity ratio causing lenders to view the company has a higher risk. With debt financing there is generally a requirement to offer company or personal assets as collateral to secure the loan. Small business owners often have to personally guarantee the loan, in full or in part. A personal guarantee means that if the company cannot pay back the debt the owner pledging the personal guarantee will repay the loan with his personal funds.

The decision to borrow funds from a bank or find an equity investor can be a tricky one. With debt you are only obligated to pay back the principle plus and interest component. With an equity investor you give up a portion of ownership in your company and your payment of dividends/distributions are variable over the life of their investment. An analysis to determine which option is best for your company should be completed before making a lending decision.