Having a good book keeping system is a great thing for your business, but it is what you do with the information in the books that matters the most.
You need to establish effective methods for financial management and control to accomplish important daily financial objectives and overall financial goals.
Having a good financial management system would help you become a better macro-manager as it would: help you manage proactively rather than reactively; help you plan ahead for financing needs, and make your loan approval process easier whenever you need credit. It would also help you provide more useful financial planning information for investors and have access to a great decision-making tool to make your operation more profitable and efficient.
It is not enough to have great products, services or marketing strategies, if you don’t manage your money well and you run out of cash all your effort will be in vain.
You must understand that entrepreneurs generally fail for one reason; they run out of money. To avoid failure therefore, you must understand the fundamentals of financial management. Once you understand the basic principles and concepts, you would be able to understand the pattern of your finances enough to make wise strategic decisions and you would be able to recognise the warning signs of an impending crisis.
You also need to have an effective managerial aptitude of the finances in your business or department. To achieve this you need to manage your finances with regards to: planning, monitoring and reporting.
Planning –taking a look at the future of the business and ensure that you will be financially healthy in the short and long-term.
Monitoring –keeping a watchful eye on the finances of the business so that when it derails you can act immediately to bring it back on track.
Reporting –having a clear picture of how your business has performed financially in the last financial period (month, quarter, year, etc), and using the information to guide your decision making for the next financial period.
These three points can be broken down into nine financial principles:
1. Keep to the cash flow budget
No matter how lucrative or promising a business is, when you run out of cash, the business will fail. Therefore budgeting helps you focus on the money as you plan for the future of your business. The truth is that accounting debits, credits, accruals and provisions are confusing and misleading. Watching your cash in the bank is a much easier method when planning. Besides it is the cash in the business bank account from one month to the other that really matters.
2. Build your financial models yourself
When the owner or manager outsources the building of the business’ financial models and forecasts to someone else, that business owner would have difficulty understanding the minute details and vital relationships within the business. He or she would not know how to change the model when circumstances in business change. If you are not sure that you can design and build your own business model or you have never done it before, then hire a professional to teach you; start with a simple financial model and cash flow forecast in a simple spreadsheet package. You and the professional can do it together on your first attempt.
3. Focus on the timing of the income
Whatever business you do, most customers will always plead that you allow them pay you late, but your suppliers will try to get you to pay them early. So if you let your customers have their way all the time, they would grab one arm each and pull until they rip you apart.
Debt is cash that you have no access to even in times of need. It is more useful to the debtor than it is to you. A manager of a small company narrated how his company “ran away” when it almost went broke from doing business with a leading retail store in Victoria Island, Lagos. He said his company had to wait until “the goods were sold” before they got paid for their supplies and his staff had to keep calling the store for their money.
You must be aware of the terms of payment and ensure that what you are negotiating is favourable to you; failure to do this could very well be the difference between success and failure.
4. Understand the nature of different types of cash outflows/expenses
Basically there are two types of cash outflow/expenses. They are the fixed expenses and the variable expenses. Fixed expenses are expenses that are a fixed sum irrespective of what is happening with the business. Examples of these are rent and salaries. You pay the same sum no matter how the business is doing. Variable cash outflows are expenses that change with the activities of the business. Examples of these are commissions and courier.
Fixed cash outflows can be very risky for your business. For instance, if a retailer records very low sales in a particular month, the company would pay less for delivery to its customers and it would pay less in sales commissions to its sales people. However it would pay the same amount in rent even though it failed to meet it sales targets. On the flip side, if business picks up and the retailer makes huge sales, the rent stays the same and the extra profit is saved.
The variable expenses might also pose a risk as these are affected by the retailer’s activities. They could easily increase with the profit and eat into it.
Note that variable expenses could also increase even when the profit has not increased. This is because variable expenses increase with the activity, and not all activities are profitable. The good news is that variable expenses can be checked. Where there is difficulty in checking a particular variable expense (that is contributing to the profit), then the business owner should consider converting that variable cash outflow into a fixed cash outflow. For instance, the increase in a retailer’s sales could increase the sum he spends on deliveries to his customers (where sales deliveries are offered for free). The retailer could change his contract with the courier company; switching from a pay-per-delivery contract to a monthly payment of a flat fee – bearing in mind that the same amount would be paid should the sales fall in the following month.
5. Keep both the daily details and the bird’s eye view in mind
Both the short term and long term progress matters; the loss of one could cost you the other. When your accountants send you those financial reports, do you really comprehend the information and the implications of what the reports are saying, and do you know how to apply whatever information those reports are giving you to make informed decisions? Your reporting system should factor in every detail that would help you and your team make short term and long term progress.
6. The bank balance does not lie
It is what your business account’s bank balance says that should guide you the most. The forecasts and analysis come next. If the account is empty, then you did badly –where it counts.
7. Mark out your break-even point
Identify your break-even point. If you have not put a cost to research time, or factored in the generator-diesel, newspapers and journals, and even mobile phone call credits then you do not know your break-even point.
8. Stay up to date
You cannot afford to be overly pedantic with your finances anymore than you can afford to be lackadaisical. Maintain a balance in between.
9. Report results with a purpose
Bear in mind what the reports are meant to achieve as you put them together.
As you work your way through these principles ensure that you understand what each principle means and apply them effectively. If you are doing well then push yourself further; seeking out what else you can do to apply them even more effectively. Progress never ends.