Once again we’re deep into tax season, the time of year when you are forced to set aside your favorite art supplies and face financial data. While all that number crunching may be giving you a headache, analyzing your financial figures is vital for the health of your business.
“You have no idea how well or poorly your business is doing if you don’t look at financial statements,” said Michele M. Stanton, an accountant who serves artists via her self-owned CPA firm in Houston and in her capacity as a volunteer for Texas Lawyers and Accountants for the Arts.
Financials are important for measuring your profitability and growth, for creating a yearly budget and making long-term plans. Do you know which financial statements you need to review? How should you analyze them? And when things are not going the way you want them to, how can these numbers help you to get out of the red?
The income statement: a key financial document for building a budget
An income statement, also called a profit and loss statement (or P&L), is the basic financial statement that artists need for analyzing and planning their business. The income statement is a report of revenue and expenses. It indicates how much a business earned during a set period of time and can be used to determine a business’s profit margin and whether earnings are headed up or down.
To create a basic income statement, calculate the totals for each category of income and expenses from one month’s record-keeping. The sample income statement at right shows the total income for January 2010 to be $3,000. Expenses total $750 and are divided into categories of expenses that include both fixed expenses (like studio rent) and variable costs (art materials, auto expenses, office supplies, shipping/postage and telephone). The more detailed you are in classifying particular expenses, the easier it will be for you to see exactly where your money is going. As you can see, the net income (total income minus total expenses) for January was $2,250. (Taconic Advisors offers a free Excel-based workbook designed specifically for artists. To request this financial tool, visit www.taconicadvisors.com, click on “Contact Us” and mention ArtBooks when you fill out the form.)
While an income statement tells about the past history of your business, a budget helps you to plan for the future. The easiest way to prepare an annual budget is to use last year’s ledger and tax return to calculate how much money you will have coming in each month and how much you will spend. You can use the income statement as a template for creating this worksheet since the format is the same for both, except that you will do this for a twelve-month time span. Create subcategories of income sources, such a salaried teaching position, and if any of your income sources vary widely from month to month, be sure to plug these estimated figures into those particular months. (For example, you might expect a jump in income in May, June and October from sales at art fairs.) On the expense side, fill in the different categories with expected fixed costs (some of which may be monthly while others, such as insurance premiums, may only be paid annually or semi-annually), then add variable expenses such as supplies, printing, office supplies, advertising and other costs that you foresee.
Numbers to notice
To analyze the financial state of your business, you need to compare the monthly income statement to what you budgeted for that month. First, take a look at net income. How close is the actual amount to what you projected? Now look at the total income and total expenses for both documents. If numbers varied greatly, figure out what happened. Did you budget for a sale that didn’t happen? If you are in the pleasant position of having a higher net income than you expected, was that due to increased sales or because you spent less than you had planned?
When benchmarks are not met, consult your budget to figure out how to get back on track. Stanton gave the following example: “Let’s say that in January, you budgeted a sale of $5,000 and expenses of $2,000 and you find that your actual expenses were $2,000 but you didn’t make a sale. You have to determine if $5,000 is coming in February or is the sale lost, in which case you might want to reduce expenses. Sometimes you can’t do that if it is a fixed cost you can’t reduce, but variable costs — marketing, travel, supplies — you may be able to reduce.”
To get the most out of your P&L and your budget, you have to monitor performance on a monthly basis and update your budget when it no longer reflects reality. Stanton advises artists to update their budget every six months; those who judiciously prepared a budget last November or December for the 2010 calendar year should revisit this document around May or June.
If you want to survive as an artist, you have to manage your cash flow. Stanton recommends that artists monitor their cash balance on a daily basis. The easiest way to do this is to set up a business account with a financial institution, then take a minute out of your day to log on to their Web site and check the balance. “It will also help find any errors that the bank makes or identify theft issues,” Stanton added.
For many companies, there is oftentimes a sizeable delay between completing a sale and getting paid, which is why management prepares cash forecasts. Since the majority of artists don’t experience a significance time gap between the two, a simpler way to get a forward view of available cash is to look at the bottom line on your budget: projected net income. Which months do you expect the greatest surplus? Are there any months when you foresee that expenses will exceed income? Your budget will help you to anticipate periods when you can expect money crunches and when extra cash will be available. Based on this information you can answer questions such as: Will I have the funds to hire additional help for a project in May? Will I be too strapped for cash if I pay booth fees, travel and food expenses for three out-of-state art fairs rather than two in September? If supplies and materials are heavily discounted in December, will I have the money to purchase large quantities at that time?
For those trying to decide if or when they will have accrued enough money to make costly purchases, it may prove helpful to see projected cash balances across a longer time period. Microsoft Corporation offers free, easy-to-use Excel templates that, once you enter income and expense data, automatically calculate cash positions for subsequent months. Go to www.office.microsoft.com/en-us, click on “Templates” and type “cash flow” in the search box.
It might seem like overkill to record the time you spend on each and every project. Who really cares as long as you’re productive in the studio, right? Wrong.
You need to know how your productivity translates into dollar signs, which means that you have to figure out your hourly income. To ascertain this figure, divide the total income derived from a specific project by the total number of hours spent on that project.
“Most artists don’t have an understanding of how many hours they spend on a project versus how much to charge for the project,” explained Stanton. “If you are spending 10 hours on project and make $100, that’s $10 an hour. But if you spend 100 hours on a project and get $100 on the project, you only get $1 an hour. Something is wrong: You are either spending too much time on it or are not charging enough money.”
Determining your hourly wage can be tricky, however, as your prices ultimately depend on your body of work and the demand for it. For more information on determining how much you should charge for your work and how to increase prices, refer to Develop a Pricing Strategy by Annie Strack in the May 2008 issue of Art Calendar.
In the event that you do foresee a cash shortfall, look across the entire spectrum of your business to identify where you can save. What unnecessary costs can you eliminate entirely? Can you reduce the cost of high-priced services by sourcing them more cheaply? Are there inefficiencies in your current operations — shipping or printing, for example — that are costing precious pennies? Lastly, be sure that you are collecting on all payments owed to you. “Even Michelangelo beat up the Pope for his money,” chuckled Stanton.
Treating it like a business
“Successful artists combine artistic talent with business savvy, or they hire someone to do it. They have the talent and the art, but they treat it like a business,” commented Stanton.
Having the mindset that you are a businessperson will help you to manage it professionally and make a profit. In fact, if you don’t make a profit in three out of the last five years, you could put your business at risk. “Otherwise the IRS could make you subject to the hobby loss rules and therefore you can’t deduct your expenses as a business, only to the extent of your income,” Stanton cautioned.
Few artists have an accounting degree, but the basic financial management practices we’ve discussed here really are not difficult to understand or implement. Just as it has taken years to hone your skills as an artist, the more time you spend learning about small business finance, the more likely you are to keep your business in the black.AC