Two Dangerous Financial Illusions

Sometimes when a company gets into financial trouble management is being deluded by things they thought were indicating financial health.

The Sales Illusion

It is not uncommon for a company’s management to see growing sales and think this is a clear indicator that everything is going fine. Increasing sales can be an indicator of financial health, but not when taken alone. If you read the posting Cash Flow – The Bottom Line you would have read about the necessity of sales being converted to cash. In my mind, as long as a sale remains in accounts receivable it is not really complete. Until collected there is always the possibility that it can become a bad debt. Because a bad debt cost more than just the sale, but also time, employee expense, and possibly inventory, it can be worse than having not made the sale.

Another illusion that increasing sales can present is to mask the fact they may not be the kind you want. If the increases are coming mostly in low gross profit margin products and services, this can be an indicator that the sales are not as high quality as at first believed. An example of how this can happen is to use low margin sales as a way to establish a relationship with customers in hopes of later high margin sales that never materialize.

The point is that thinking increasing sales by itself is a clear indicator of financial health falls in the category of dangerous financial illusions. There is more to be considered, such as are they quality sales and can they be collected?

Look How Profitable We Are!

On numerous occasions I have seen a company that looks very healthy when just looking at comparative income statements. There may not only be increasing sales but profits in dollars and percentages are growing. Yet, just looking at a current income statement compared to prior years, quarters, and months only tells part of the story.

The balance sheet is a snap shot of the current financial strength of a company. It shows you things like how much cash is on hand, how much cash is tied up in accounts receivable and inventory, and how large are liabilities In combination with the income statement, analysis can provide key financial indicators such as whether receivables are being collected in a timely manner, is inventory being turned over often enough, and if liabilities being appropriately managed.

It is not uncommon for a company to be extremely profitable yet still struggle to have sufficient cash because of mismanagement of assets and liabilities. Just like increasing sales, profitability also can fall in the category of dangerous financial illusions.

When you are being deluded by these two items (growing sales and profitability) in to thinking your company is financially healthy, you will find yourself dragging around a financial ball and chain.

financial-ball-and-chain

Take a closer look at your company’s financial picture, do some serious analysis, and then ask yourself, “Is the company really financially healthy or are we being deluded by a financial illusion?”

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

Share

Leave a Reply

Enter your email address:

Delivered by FeedBurner