Ask Us How: The 7 Ingredients to Financial Success
Published on October 16, 2013 under NSW Business Chamber Partnership
Why is it important?
In today’s economic climate it is fair to say that running a business has never been so challenging. Despite being the unsung heroes of the Australian economy, SMEs are challenged by economic uncertainty, a continuing technological revolution, increased global competition and political chaos on our own shores. Whilst a lot of these elements are out of your own control, there are some vital elements that you do in fact have control of – the key one being your finances. These very ingredients are key to ensuring your business can continue to succeed regardless of how many external variables are thrown your way. Understanding your financials is one most important steps you can take for bulletproofing your business.
What to do
No doubt you have an established relationship with an accountant. A professional who prepares your tax returns, BAS and other compliance based tasks. It is time to start insisting on more out of this relationship and perhaps start engaging them to assist with implementing the following 7 ingredients into your business.
So what are the 7 ingredients?
1. Create efficient systems
2. Understand your key financial statements
3. Control your expenses
4. Set and monitor budget
5. Monitor your key accounting ratios
6. Work with regularly updated profit and cashflow forecasts.
7. Manage debtors efficiently
Each of these ingredients can be discussed in isolation for hours. They each serve a very important role in the big picture. I will provide a brief summary of each ingredient below to help get you started on educating yourself on the key financials of your business.
Create efficient systems
Over 95% of SMES are operating blindly without any knowledge of the financial implications of each sale they make. Knowing the accurate profit of your services will mean you can plan much more strategically moving forward. There are many positives to creating efficient systems in your business, such as:
- You will no longer have to spend too much time and money on people costs
- You will be able to generate information and intelligence that will affect your decision making across the business
- You’ll save copious amounts of time
It comes down to the effective use of technology. Gone are the days where savvy technology is only accessible to the big corporate. Cloud-based software is now affordable for the SME to embrace, and if you do not, you will be left behind. There are two core components to how SMES must embrace building sufficient systems. The first is a Client Relationship Management System (CRM) and the second is an Accounting System. A CRM will monitor core functions of your business such as finance, sales and marketing, client management, inventory and reporting. An Accounting System will streamline your different accounting functions such as accounts payable, accounts receivable, payroll, departmental financial data, fixed assets and so on. Often you can get software that combines the two.
Understand your key financial statements
There are three financial statements you need to understand:
- Profit and loss statement - (the Income Statement) – this is the summary of your business's earnings, expenses, and net profit (or loss) over a specific amount of time.
- Balance sheet - this is a record of your business's assets, liabilities, and capital, up to a specific point in time.
- Cashflow statement - this will show the actual inflows and outflows of cash coming into and out of your business.
Many business owners have not been schooled in accounting; they are schooled in their own area of expertise and often have a limited understanding of how financial analysis can help them manage their businesses effectively.
Financial statements are more than a simple listing of business income and expenses. Appropriately prepared financial statements can show you the cash flow of your business, any outstanding debts, and the value of your assets. Basically, once you do this, you'll see that the total in your cheque book is not necessarily the income you have earned. There is far more to income than actual deposits in the bank.
Control your expenses
The importance of business spending is underestimated in business and it is important to know how to manage spending for the future profitable growth of your business. The management of your spending is a critical art to being a successful business person.
It doesn’t necessarily require a deep level of financial expertise but does require a level of understanding around business needs and expense allocation.
There are three components to controlling your expenses:
- Variable cost spending which are linked to the product you sell
- Fixed overheads
- Capital spending which can range from basic new equipment purchases to new business acquisitions
By reviewing and modifying your business structures and costs you are likely to improve profitability. Be wary of cutting costs that may have a negative impact on your business, such as investment in staff, marketing or technology. Many people see things simply as a cost, but do not forget to look at the difference between as simple cost and a value added expense.
Set and monitor budget
A budget is an estimate, based on what you know today, on what the net profit of your business and what the cashflow contribution would be from your business in the future.
It is normally done for a 12 month period for the financial year, say from 1st July 2013 to 30th June 2014. Most businesses would prepare their budgets during May and June 2013 for this period. It’s most important function is to determine what revenue you need to achieve in order to reach your profit targets. Comparing this to current year revenue is your growth number. If you compare this to your overall industry this will give you a good sense check of how realistic your targets are.
3 main reasons to set a budget
1. Anything that requires forward planning, such as:
- Setting goals for your sales people so you will achieve your revenue numbers OR
- Setting up new sales channels in order to meet revenue numbers.
- How much you are spending with key suppliers – can you negotiate better pricing?
- How many staff do you need to hire?
- Do you need more space?
- What to do with surplus profits from a tax planning & asset management viewpoint
2. Where would a significant change in your industry impact your bottom line, eg:
- Increase in supplier pricing
- Something going wrong in your supply chain
- Movements in fx rates
- Changes in tax rates
- Changes in employment costs
3. Financial control – if you have a detailed expense budget that includes all of your cost categories, and you get reports on how much you are spending compared to that budget, may allow you to pick up any unauthorised spending early.
Your business results will always be a factor of elements you can control and those you can’t. Going through this exercise helps you manage those things you can control and at least give you enough warning on those you can’t and to give you the time to find a different way to fix those problems.
Monitor your key accounting ratios
You can monitor your business's performance with tools called key accounting ratios, which help you to interpret financial information about your company. The more you know about how your business is performing, the easier it will be for you to make informed decisions about how to manage and grow your business.
Monitoring your results is critical and has enormous value in building and selling your business in the long term. Large corporates treat this reporting extremely seriously to identify trends and areas of the business that need addressing as a matter of urgency.
Working regularly updated profile and cashflow forecasts
A Cashflow management report has become one of the most powerful reporting tools for businesses needing to closely manage their cashflow and they are seeking guidance from advisors in order to remain on top of it each month.
So what is cashflow? It is a report that shows a company’s inflows and outflows over a specified period. The report will normally begin with a starting balance and generates an ending balance after taking into account all cash receipts and paid expenses during the period.
This day and age, businesses are trying to forecast what their cashflow position will be over a long period of time in order to manage the inflows and outflows more effectively. In this instance timing is everything and having the right cashflow forecast in place will show you if/when you need to borrow money, how much you would need as well as when/how it can be repaid. In either case, cashflow management is a necessity for the survival of many businesses today.
Manage debtors efficiently
Cash is the lifeblood of a business, so smart management of your debtors is crucial to success.I work with many of my clients to understand why this process was difficult and re-engineered their accounting processes around debtors, improving their collection times from 60+ to 30 day averages.
Managing your debtors efficiently is one of the key strategies to improving your cashflow – it is money owed afterall. It’s important to create an efficient system to make this part of the business run like clockwork.
On a final note
Understanding your financials is the only way to maintain control of your business and to be able to set and achieve goals in a strategic way. I encourage you to start a discussion with your accountant and start implementing some these ingredients today, if you aren’t already.