For those business owners who feel they don't have strong financial backgrounds, rest easy. Financial management is really about understanding what those numbers represent. It is really all about managing those underlying facts and conditions.

This means you can effectively manage your business finances by ensuring:

a) you manage your cash flow
b) you understand basic financial statements, budgets, and financial reports
c) you have a system that delivers timely, relevant, accurate and properly formatted reports
d) the system identifies and reports the right numbers, generally called ‘Key Performance Indicators”
e) you take appropriate action when matters come to your attention
f) you use financial information and key performance indicators to predict and prepare for the future

Cash Flows 
It is often said that Cash Is King because it is the life blood of a business. If you have no cash, you cannot operate and if you still have payables and no cash coming in to pay them, you are bankrupt. This is why it's important to keep an eye on cash flows.

A rolling projection, that is, a frequently revised cash flow projection, is the most often used tool to predict what will come in and go out. Essentially, this puts on paper what a small business owner already knows. You have receivables coming in, and bills you have to pay… now exactly how much are we talking about? The more intricate the business, the more factors you have to consider. Cash flows should be tracked at least monthly, and more often the more crucial it is. Even if you do not look at a full cash flow report, it is wise to keep track of receipts, disbursements and cash balances daily

A comprehensive cash flow statement is typically broken down into three categories: operating, investing and financing cash flow. As indicated, it aggregates cash flow from operations with cash flows from financing activities, ie getting and repaying loans, and from investing activities, i.e. buying and selling assets such as equipment.

To improve your cash flow, work on all elements of your working capital. This includes cash balances, accounts receivable, inventories and accounts payable. To improve cash flow, collect receivables faster, invest less in inventories and\or turn the inventory faster, and stretch payables by negotiating longer payment terms.

Financial Statement Ratios 
Financial statement analysis is also very useful. The two basic statements are the balance sheet, which is like a snapshot of the business at a certain date, and the income statement, which measures the result of operations for a given period. The key here is to calculate financial ratios and trends because financial statements in themselves disclose limited, albeit important, information.

Numerous valuable ratios exist. The important part here is to know which ratios to track and what they tell you about the state of your business.

The three most important balance sheet ratios are:

a) The Current Ratio, which is current assets divided by current liabilities
b) The Quick Ratio, which is like the Current Ratio, except that current assets only include cash and receivables And
c) The Debt Equity Ratio, which is the total liabilities of the company divided by its net worth.

The current and quick ratios measure the company's ability to pay its bills as they come due, while the debt equity ratio measures the company's ability to survive over the long-term.

The income statement focuses on revenues, expenses and net income (or loss) over a defined period of time. It measures the company's ability to turn sales/revenues into profits.

Its most important numbers are total sales, gross margin ( total sales less all direct, variable costs), net operating income, income before taxes and interest, and after tax income. A useful exercise is to calculate all expenses as a percentage of sales, then track these percentages over time.

Many other financial statement ratios exist. You can talk to your accountant who should be able to guide you in choosing the best ones. What is important is to look at trends. Measuring increases and decreases over time tells you exactly how the business is performing. For example, taking a very simple example, sales per sales employee is certainly good as a means of measuring individual sales people in a given month, but decreases over time point to problems with your sales force.

Key Performance Indicators 
Key Performance Indicators, also known by their abbreviation KPI’s, are a core set of measures that indicate a business is healthy and moving in the right direction. More often than not they include the cash flow information and the important balance sheet and income statement ratios explained above, along with other important operating information. For example, accounts receivable and inventory turnover, average sales dollars per transaction, number of product items produced, labour hours worked, number of customers, percentage market share, service calls, complaints, and many others could be important information to track and trend.

One of the most important non-financial indicators any business must track is what causes sales. When you know, you can devote resources to ensuring sales happen, and when sales decrease, you can immediately take action. Every business has one or two primary activities that causes sales to be made. Maybe it’s the number of enquiries, sales calls, referrals, walk in traffic, networking events attended, seminars given…only you know. Identify them (and most often it is only one or two key things) and track it and influence it.

Use the same approach for all elements of your business. Using the "what causes" approach, ask what causes operations to be more profitable? What causes an increase in customer satisfaction? What causes employee satisfaction? Answer these questions and then measure and track and trend those activities. These are your non financial key performance indicators.

Whichever they are for your business, keep in mind that KPI’s should be measurable and representable by a number, they should relate to company activities and processes, they should tell you if you are regressing or improving, and acting on the underlying activities should effect a change in profitability, cash flow, or some other important measure of success.

Management information needs to be presented in a way that makes the important trends easy to see. You achieve this by restricting the number of figures you monitor per report, and by visual representation using graphs and charts. Exceptions reporting, which highlights only those issues that need attention, is another good practice, though all results should still be reported.

In addition, those preparing reports should include a written commentary which includes input from those closest to the activity. This commentary should explain any important changes and the reasons behind them, which is then incorporated into the decision you make about who should do what, how, where and when to get you back on track.

Developing Financial Discipline 
In order to be financially disciplined as an organization, you must build a culture that embraces the discipline as an important tool for success, and everyone should be rewarded for achieving improvement.

The first step is to establish a reliable financial reporting system that delivers the requirements for both financial reporting and KPI reporting. Ensure you segment your business by products, markets, customers and any other meaningful sorts, and that you have an accurate costing system that attaches the appropriate costs to each segment and activity. This is the infrastructure. Now make sure the people side works by ensuring those responsible for activities are in fact empowered to make decisions, are accountable for them, and most importantly, recognized and compensated for their wins and success in achieving set goals. Ensure you widely communicate all expectations and results, and continuously promote and support improvement in your KPI’s

In addition, it helps if you yourself look for ways to improve. After all, your attitude is your own firm’s KPI. Have your key staff members ask questions and challenge your thinking, learn about new tools that help deliver better information in better ways, be open to new techniques, train your staff and encourage them to improve themselves. Your attitude towards developing and reporting KPI’s , and using them to improve the business, will rub off. As will slacking off the discipline.


© 2015 John B Voorpostel CPA, CA, CMB
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