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April 1994

Financial information used by small independent retailers. (The CPA in Industry)

by Palmer, Kristine N.

    Abstract- Thirty-six small independent retail owner-managers were surveyed to find out how important timely and accurate information is to small business. Results of the interviews showed that most of the participants (92%) kept daily records of sales and other transactions, although only a third (33%) of them used computerized accounting systems. The financial statements most prepared and used by the surveyed retailers were found to be their checkbooks (100% prepared and used) and the profit/loss statement (100% prepared, 92% used). Findings also revealed that a large majority of the respondents did not have any written business plan, but a quarter of them claimed that they do have some sort of a plan in their minds. The study's results suggest that most small business owner-managers need financial information for guidance.

Interviews with 36 small independent retail owner-managers were conducted to find out. Included in the study were businesses whose principal merchandise were drug/pharmaceutical, hardware, jewelry, clothing, televisions and appliances, furniture, and floral arrangements. Of the 36 businesses in the final sample, 53% had six or less employees, 25% had between six and ten employees, and 22% had more than 10 employees. Eleven percent had sales between $40,000 and $100,000, 20% had sales between $100,001 and $200,000, 22% had sales between $200,001 and $400,000, and 47% had sales over $400,001. Twenty- two percent of the interviewees were organized as sole-proprietorships, 61% were corporations, 14% were a partnership or Subchapter S corporation, and 3% were co-ops. All of the businesses used the cash method of record keeping.

Results of the Interviews

Only 33% of the businesses used computerized accounting systems. However, 92% kept daily records of their sales and other transactions. All of the businesses had some type of financial statements or tax returns prepared annually.

Table 1 illustrates which financial statements these owner-managers prepared and what percentage used the information. The question for usage was phrased so that a "yes" answer could simply mean that the owner-manager compared last year's financial statement to this year's. The degree to which the statements were used varied greatly. Some only glanced at the statements to determine if any number had changed, while a few did thorough monthly comparisons to aid in their decision making. Some knew what numbers should be on the statements, while others had no idea what the numbers would show until they received the financial statements when their taxes were prepared.

The most prepared (100%) and used (92%) "financial statement" was the profit/loss statement, as it had to be prepared for income tax purposes. The owner-managers were interested in the dollar value for sales and the "bottom line." Balance sheets were prepared by 86%, but only 75% "used" the statement. Even though a cash flow statement was only prepared by 22% and used by 19%, 100% of the owner-managers knew the balance in their checkbook and used the checkbook to make most of their managerial decisions. Common-sized statements were not a common tool used. Only 17% prepared and used common-sized balance sheets and 39% prepared and used common-sized profit/loss statements. Some of the owner-managers did comment that they had received statements with percentages down the side, but did not understand what the percentages were. So they weren't used to make decisions.

Forecasting statements were prepared and used by 36% of the owner- managers. The owner-managers who were very familiar with their accounting records and kept their records in house were the users of the above tools.

Other areas of information gathered by these owner-managers included sales, accounts receivables, inventory, and accounts payable. The cash register was used by 58%, and 33% used sales tickets to gather sales data. Sales returns and allowances were recorded by 86%. The "sales" figure was the primary concern for most of the owner-managers. One hundred percent of the owner-managers knew what their sales were at least monthly and compared these figures to the previous year at the same time. However, most did not have any idea as to their cost of goods sold, thus did not know their gross margin until they received their profit/loss statements at the end of the year. Although some were aware of the acute relationship between the sales and cost of goods sold figures, most only compared the sales figures without considering how cost of goods sold could affect the bottom line.

Cost of goods sold was calculated annually by 52% and monthly by 42%. Gross margin was determined by entity for 66%, and by department for 28%. When asked if the gross margin or cost of goods sold information was helpful in making decisions, 67% said yes, although most were more concerned about sales dollars, than cost of goods sold dollars. If changes were made, they usually involved the sales prices, not the cost of the goods sold. Ninety-two percent did not record mark-downs as they occurred, but recorded the products sold at their selling price, as they did not think keeping track of markdowns was important.

Accounts receivable were accepted by 89% of the businesses. Of these, 91% had a policy for aging their receivables, and 100% had policies and procedures for extending credit and collecting past due accounts. Although the policies and procedures were verbalized very quickly, these procedures were not written down, as the owner-manager dealt personally with these situations.

All the businesses conducted physical inventory counts. Seventy-eight percent did actual counts once a year, 14% did physical counts twice a year, 5% did counts monthly, and 3% had physical counts weekly. Only 11% hired outsiders to do the physical inventory. Although for most, actual physical counts were done on a yearly basis, all the owner-managers believed they knew what was on their shelves. Those with computerized accounting systems had computerized perpetual inventory systems. Others used perpetual "visual" systems. Since these individuals were in their place of business almost all of its operating hours, they felt they had a very conscious idea of their inventory.

All the owner-managers had procedures for recording and paying accounts payable. Only 44% kept track of discounts they had taken on a payment within a discount period and compared this information to what they could have taken or what they had taken in previous periods. The others either did not take the discounts, or simply recorded the price for the inventory at the price they paid for the merchandise. Those not taking the discounts stated that the discounts were not material enough to be bothered with. Those who consistently took discounts knew that the discount percentage stated was not the true annual percentage of savings.

Business Plans Are Rare

A large majority (89%) did not prepare a written business plan, although 25% of these said that they do have a plan for the business in their minds. Eighty-six percent of those interviewed did not prepare written budget, but of these, 42% said that they had a mental budget, and 14% budgeted for merchandise only. Both of these decision tools were not used primarily because the owner-managers did not have the time to prepare them, nor did they totally understand how to prepare them. Those who used these tools were convinced that their use substantially increased their "bottom lines."

Financial ratios (at least one) were calculated by 22%. Break-even points were calculated by 31%, and inventory turnover was calculated by 42%. Ninety-two percent did not have an automatic reorder point. Reordering was primarily determined after observing what was on the shelf, considering what the reorder time was, and determining what the owner-manager felt the demand for the product would be. Seasonal fluctuations were recognized and adjusted for by 83%. Again, usage of these managerial tools was determined by the merchant's knowledge of them. The owner-managers using ratios also compared them to their industry averages. Several who did not use these tools expressed a desire to learn about them, while others felt it would be a waste of time.

The owner-managers were asked which expenses they watched most closely. Labor was the most mentioned (29%), followed by inventory/cost of goods sold (23%), advertising (19%), and all operating expenses (11%). A few owner-managers did not watch any particular expenses (8%).

Table 2 illustrates who owner-managers used to prepare the balance sheets and profit/loss statements. The most common preparer was the CPA, 50% for the balance sheet and 53% for the profit/loss statement. The owner-managers were also asked if the preparers explained the financial statements to them. Fifty-three percent said that the preparer explained the balance sheet, and 56% said that the preparer explained the profit/loss statement.

However, these answers were quickly followed by comments such as: "If l know what questions to ask" and "if I want to pay the high fee for the preparer to explain what he or she did." Some owner-managers worked very closely with their preparer and were very satisfied with the information they received and felt that the information helped them make managerial decisions. These were the owner-managers who used most of the decision tools discussed above, and coincidentally had been named as being "successful."

When asked from whom the owner-managers seek financial advice, 28% said from no one, because there was no one else who knew their particular business well enough to consult. Of those who sought advice, the most common source was their CPA (45%). The other sources included bankers (20%) and other business people (15%). Their personal experience in their own business seemed to be the prevailing source of information. The amount of information sought depended greatly upon the circumstances of the business and who was felt to be "trustworthy."

The Struggle for Survival

Small independent retail owner-managers are struggling for survival in today's economy. They are trying to make the right managerial decisions with the information they have gathered that they feel is important or that they know to collect. Most of the information collected is found in the minds of the owner-managers, not written down or recorded in an accounting system. They are quick to explain that writing down this information would take too much valuable time and that time is needed elsewhere in the business.

When comparing the accounting information used by the businesses which were named as "successful" versus "average" versus "barely surviving," the more accounting information which was used was directly related to the perception of success by others. The more knowledgeable the owner- managers were about the financial position of these businesses, the more successful the businesses appeared to be. Where did most of these "successful" owner-managers get their information? From their own accounting systems. How did they learn to obtain information from them? These answers ranged from "I've been in the business so long I have learned which numbers are important"; "I have someone in my family or a close friend who helped me set up a system that was right for my business"; "I have had some form of training in the accounting area"; to "the preparer of my financial statements works with me."

These "successful" owner-managers also had goals set for their businesses. They knew what their niche was and who their competition was in the marketplace. They could easily explain what their business plan was and what problems could cause them to make changes in their plans. Each knew exactly what their financial status was today compared to yesterday, and what they planned to do to try to achieve their goals for tomorrow.

These were owner-managers who had business plans and budgets at least in their minds, who used common-sized and forecasting financial statements. These were the ones who used ratios and compared them to their industry average, or knew what the ratios should be for their business. They also knew approximately the sales dollars necessary to break even and how many inventory turns where required each year. This is not information that can be easily obtained by reviewing a tax return or financial statements sent to them from the preparer. Each of these owner-managers also had a very good relationship with the preparer of their financial statements and felt that the preparer understood their business and worked with them in their fight to succeed.

The above was not the case for the businesses which were having a more difficult time. The biggest problem seemed to be that they were not as cognitive about their niche, competition, goals, and financial position as the more successful owner-managers. To many, the idea of keeping accounting information was nightmare. The preparers of their financial statements did not volunteer information which could help them to better understand financial information they had received. The financial statements were simply a necessity for tax purposes. The businesses were being run by "gut-instinct" and the "seat-of-the-pants" approach, which is the exact wording several of the owner-managers used. These were motivated individuals who worked long hours trying to make their businesses succeed, but were struggling as they did not have all the information they needed to make the most informed management decisions.

Most small business owner-managers are very private and distrusting when discussing their financial positions. Some of those interviewed go to a preparer outside of town, simply because they do not want to take the chance of any of their information and secrets leaking out into the community. The economy and increased competition from chains has made them more suspicious of individuals or groups offering "help," yet this appropriate help is what they need to succeed.

As the literature indicates and this study reinforces, most small business owner-managers are in need of financial guidance. This, however, does not mean that simply changing their shoebox method of information gathering to a sophisticated accounting system will solve their problems. The accounting system has to fit their particular business and needs. The system has to produce the information they need to make decisions. Deciding what information they need is where the consultation with the preparer of their financial statements is imperative. The owner-managers are individuals who know the mechanics of their particular business, they just don't always understand the financial details.

The true "success" stories found in this study were the result of a lot of hard work, long hours, and determination by the owner- managers.

Kristine N. Palmer, CPA, Longwood College

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