Finance is the core of any business. Let’s be honest: there is no sense in running a business that is not profitable (unless it is for a charitable cause). The sad reality is many business owners don’t spend enough time on managing and analysing their finances because it is often perceived to be boring, complicated or only a support function within a business. The truth is however, that the more you manage your finances, the more successful your business will become.
A finance function can be outsourced or handled by the financial officers in your business, but as a business owner you should still know and understand the numbers. The important numbers will differ from business to business – what might be critical for one type of business, might not be important for another type.
Here are the six most important financial aspects for the majority of businesses.
1. Cash Flow
Cash flow is possibly the most important number in any business. A number of large corporations have closed their doors due to cash flow problems. Even a profitable business with good sales can experience cash flow problems. This refers to the physical cash that you have available in your bank or investment account. Cash is needed to pay the expenses, pay creditors and to grow your business.
Cash flow management goes hand in hand with how well you are managing your debtors and creditors. You could have had great sales; but many of your customers or clients have not paid you or you need to pay your suppliers and expenses before receiving payment. Both these scenarios can create serious cash flow problems.
Your sales determine your revenue or turnover. In other words the revenue or turnover before cost of sales or expenses have been deducted. You constantly want to drive your sales numbers and exceed the set sales targets. In theory, the more you sell of your product or service, the more profit you will make (although this is not always true!). Therefore, it is important for any business to know and manage their sales numbers.
It certainly helps to pro-actively identify a decrease in sales and investigate the reasons for it.
It is also important to identify trends. For example, an ice-cream company might see a decrease in sales during the winter months but a spike in sales during the summer months. By knowing these trends, you will know whether a decrease in sales is due to the nature of the business or whether there is a problem
Profit is determined by deducting cost of sales, expenses, and tax from your revenue or turnover. You want to end up with a profit and not a loss balance. This is where your cost of sales, expenses and tax exceed your revenue or turnover. It is possible to reach sales targets and still make a loss. That is why the costing and pricing of your product or service is a critical aspect of your business and includes expense management within your business.
Profit can be increased by either increasing your revenue or decreasing your expenses. You will pay tax on profit; therefore, you need to also take tax into account when you do your budgets and forecasts.
4. Direct and indirect costs
Profits are directly impacted by expenses so it is important to know both your direct costs and indirect costs since both these costs play a critical role in the pricing of your product or service. A particular product or service can be perceived to be profitable, but once you calculate the indirect costs, the product might be selling at a loss.
For example: Selling hotdogs, your direct costs will be the cost of your bread rolls, the sausages, the sauces, the butter and the packaging. These direct costs are attributed to delivering your product or service.
The indirect costs might include things like the electricity to heat up the sausages, the salaries of staff members preparing and selling the hotdogs and your marketing costs. Ensure that you take both direct and indirect costs into account when you set a price for your product or service or to determine your profit margin.
5. Budgeted numbers
A budget is crucial for any business regardless of its size. A budget is an effective tool to help you plan for the year ahead. You also want to do forecasts for the medium and longer term i.e., 2-5 years and 5-10 years. Forecasts help you identify big future expenses that you ideally want to start planning for i.e., moving into a bigger office, replacing your computers or buying a delivery vehicle.
It is inadequate to have a budget if you don’t compare your actual revenue and expenses to your budgeted numbers. Comparing your actual numbers against your budget and analysing the reasons for variances, gives you the valuable information you need to make effective financial decisions.
It is ideal to run your business on a cash basis. This is not always possible and the nature of many businesses forces you to allow for debtors (also referred to as accounts receivable). Long outstanding debtors can create cash flow problems and irrecoverable debtors can cause your business to close down.
You must always know your debtors and constantly manage their debtors’ balances. Adopt a payment policy and communicate it to your customers or clients. Do credit checks on your customers or clients and stop providing products or services to them if they don’t pay you within your set timelines.
By familiarising yourself with these numbers of your business will give you the information you need to take decisions on growth, change strategies and ensure a financially secure future for your business.
Written by: Ronel Jooste
CA(SA), Financial Consultant, Speaker and Author of the award-winning book ‘Financially Fit and Wealthy’