“Money, money, money.., Must be funny.., In the rich man’s world. Money, money, money.., Always sunny.., In the rich man’s world” – C’mon! Everyone knows that classic Abba tune. And, I’m sure many of you have dreamt of a similar sort of setting to their nostalgic video- surrounded by money and jewels? I’m sure most business owners have!
But, if you think about it, is it really a rich person’s world or a smart person’s world? A smart business owner recognises the importance of financial management.
Studies suggest low financial literacy levels and a lack of financial discipline may be reasons small businesses ultimately fail.
Financial management and planning are crucial to the success of any business- small and large. That is why a full comprehension of their importance and value is necessary when starting a business or expanding one.
So, shall we begin..?
Firstly, let’s start with financial management.
Financial management uses statements that reflect the monetary condition of a business to identify its relative strengths and weaknesses. It enables the owner to plan future financial performance for capital, asset, and personnel requirements to maximize the investment return.
Financial management identifies the need to tackle a somewhat different set of problems and opportunities in a small firm than those confronted by a large corporation.
An obvious contrast is that smaller firms don’t usually have the opportunity to sell stock or bonds to raise funds publicly. A small business owner must rely primarily on trade credit, bank financing, lease financing, and personal equity to finance the business.
An area of particular concern for a business owner lies in the effective management of working capital. The below equation can define it:
Working Capital = Current Assets – Current Liabilities.
Lacking control in this area is a primary cause for business failure in both small and large firms.
The business manager or owner must continually be alert to changes in working capital accounts, the cause of these changes, and the implications of these changes for the company’s financial health.
The most effective method to highlight requirements in this area is to view working capital in terms of its major components:
Cash and Equivalents – The most liquid form of current assets. Cash and cash equivalents require constant supervision.
- Is the cash level adequate to meet current expenses as they come due?
- What are the timing relationships between cash inflows and outflows?
- When will peak cash needs occur?
- What will be the magnitude of bank borrowing required to meet any cash shortfalls?
- When will this borrowing be necessary, and when may repayment be expected?
Accounts Receivable – The balance of money due to a firm for goods or services already delivered or used but not yet paid by the customer. Critical issues in this area include:
- Is the amount of accounts receivable reasonable to sales?
- On average, how rapidly are accounts receivable being collected?
- Which customers are “slow payers?”
- What action should speed collections where needed?
Inventory (stock) – This can make up to 50% or more of a company’s current assets. Key questions to consider in this area include:
- Is the level of inventory reasonable to sales and the operating characteristics of the business?
- How rapidly is inventory turned over to other companies in the same industry?
- Is any capital invested in dead or slow-moving stock?
- Are sales being lost due to inadequate inventory levels?
- If appropriate, what action should increase or decrease inventory?
Accounts Payable – These are amounts due to vendors or suppliers for goods or services received but not yet paid for.
Key issues to investigate in this category include:
- Is the amount of money owed to suppliers reasonable to purchases?
- Is the firm’s payment policy such that it will enhance or detract from its credit rating?
- If available, are discounts being taken?
- What are the timing relationships between payments on accounts payable and collection on accounts receivable?
Bank Debt – amounts owed to banks or other lenders are a second primary source of financing for the business. Essential questions in this class include:
- What is the amount of bank borrowing employed?
- Is this debt amount reasonable to the equity financing of the firm?
- When will the principal and interest payments fall due?
Now, let’s move on to Financial Planning.
There is a straightforward reason to understand and observe financial planning in your business… And that is to avoid failure.
Financial planning affects how and on what terms you will attract the funding required to establish, maintain, and expand your business.
Financial planning determines the raw materials you can afford to buy, the products you will be able to produce, and whether or not you will be able to market them efficiently. It affects the human and physical resources you will be able to acquire to operate your business. It will be a significant determinant of whether or not you will be able to make your hard work profitable.
A clear, well-documented financial plan that establishes goals and includes the use of Pro Forma Statements and Budgets to ensure financial control will demonstrate not only that you know what you want to do but that you know how to accomplish it. This demonstration is essential to attract the capital required by your business from creditors and investors.
One important factor I would like to finish with is the difference between what we do, business coaches, and what accountants do.
Accounting and financial management both deal with money management, but there are distinct differences between the two disciplines. Accounting looks backwards at work already done, whereas financial management looks ahead with projections and helps with planning.
Contact us now for a free coaching session and more tips on using financial management to grow a sustainable business model. You can also email us for Quick Cash Flow Strategies or a Basic Weekly Cashflow model.