What are the Basics of Managing Small Business Finances?

I’ve been reflecting on the articles I’ve sent out in the Creative Finance & Management newsletter. Some of them have a bigger company feel to them, and if you own a smaller company you may be feeling like I am not saying anything relevant to you.

I am also conscious that although I am trying to say things that are relevant to businesses with turnover between £1m and £25m, in reality the difference between businesses at £1m and £25m are huge. And the difference between businesses with one or two employees to those with over £1m turnover is also fairly large too.

We tend to talk about small business as if it were one category. But small business is actually more diverse than large business! (It makes me wonder how we can talk about an “SME sector” when we lump the one-man bands in with the £100m complex group.)

I have also met quite a few people running sub-£1m turnover businesses who wish there was some service like Charis FD’s to help them with their finances. Watch this space! It is on my radar and I hope to come up with something in the next few months.

But in the meantime I have been trying to think about what I could say to help small businesses of all sizes. What are the basics? The fundamentals? What are the financial management principles that will keep you on the right course from the tiny beginnings to the multi-million pound success story?

If you have read the full length article that I sent you recently – “The Essentials of Financial Management in Small Businesses” – then the points below will not be new to you. If you haven’t read that, I would commend it to you. You can download it by clicking on this link:

http://www.charisfd.com/page11/page11.html

In summary the basic principles that apply to everyone are:

1. You have to make a profit

2. Cash really is King

3. Have a plan and know what’s coming

4. Stick to the plan

5. Review your progress very regularly

6. Never spend more than you have to

First, you have to be making a profit. If you don’t make a profit in the long term you would have been better off if you stopped doing business. Ok, in the early days you may start off with losses while you are winning customers. But if you don’t make a profit quickly enough you will run out of money. Investors and lenders don’t like putting more money into businesses that are not profitable.

So don’t ever lose sight of that. Don’t ever say to yourself, “oh well, I’m still in the loss-making phase.” Instead, ask yourself, “how can I get us profitable more quickly?”

Second, if you run out of cash your business is finished. Cash is like the fuel in the car. Once it has dried up, the car is going nowhere. If you are trading at a loss, at least you are still trading! If you have no cash, you are not trading at all.

So get your customers paying on time, don’t hold too much stock, don’t pay suppliers too early (and make sure your credit limits are adequate by being a good payer), and make sure your business is properly funded by doing cashflow forecasts.

Third, planning is essential, whether you like it or not. You have to know where you want the business to go and what you want it to achieve, and then ask yourself how it is going to achieve it. And do that with detailed questions until you know exactly what you need to do.

Many businesses fail because they didn’t have a plan.

Fourth, stick to the plan. Obvious point, but worth making. A plan is pointless if you are not going to follow it. Make sure it is detailed enough to follow, but flexible enough to allow changing course if it’s not working as well as you thought.

Fifth, measure your success against the plan. That’s a positive and a negative. You must measure your success against the plan. But you should not waste time measuring things that don’t tell you how well you are performing against that plan. Your plan should include every important element in moving the business towards your visionary objective.

There are some things you always need to look at: Your income statement each month, your balance sheet, your debtors list and your cashflow forecast.

Other metrics you need to define and decide on for yourself, because they should relate to your unique business and your unique plan. Just ask yourself how you will know whether the business is succeeding for each key element of your plan.

Finally, following on from the point about making a profit, don’t spend more than you can afford. Easy to say. Not so easy to do.

It’s all about challenging every piece of expenditure that is proposed, whether it is in the business plan or not. Is it really necessary? Could it be deferred? Broadly speaking, if the spending does not either help to keep you in business or contribute to increasing your profit in the future, then it is not going to help your business. So don’t do it. Sometimes this is a subjective judgment, and you will not really know whether you got it right or wrong. But simply committing yourself to that frugal mindset will mean that you are probably going to get it right mostly, and you will have a more profitable and more successful business because of it.

Work within these principles and you will be more likely to succeed than 70% of small businesses out there, in my estimation. I hope you succeed!

The Importance of Regular Review

The Importance of Regularly Reviewing Your Finances

I was reminded the other day that many smaller businesses struggle
with knowing what financial information they should be looking at
on a regular basis. Some don't look at any financial information,
apart from maybe their bank statement, from one year to the next.
It's kind of a surprise once a year when the accountant takes their
plastic bag of receipts (or perhaps these days a memory stick might
go with the plastic bag!) and two weeks later they sit with their
accountant to find out how they did. Those in that position lack
confidence in whether they have enough money to spend on things for
the business, and they don't know whether they can do things better.

Other owners of smaller businesses lack confidence that they are
looking at the right things on a regular basis.

So here's a simple little checklist to allow you to healthcheck
what information you are looking at on a regular basis. Apologies
to those for whom this is stating the obvious.

First, you need to place priority on keeping the accounts up to
date on a daily basis or weekly basis at the least. If the
information in the accounting system isn't up to date, then the
reports you get out won't be up to date either. So you need your
bookkeeper, accountant, accounts clerks - whoever keeps your
accounts - to regularly post invoices (sales and purchases), bank
receipts and payments on your accounting system.

Second, you need to look at a profit and loss statement every
month, at least. A profit and loss statement (accountants tend to
call it a "P&L") shows your income/revenue and costs in the last
period. One minus the other is your profit or loss for the period.
The reason you look at it as a statement is that it can tell you
many interesting and useful things that you need to know.

For example, you may get a big surprise when you see your gross
margins (gross profit as a percentage of sales revenue) are 40% and
not 60% as you thought. So it prompts you to find out what's going
wrong there. Or you didn't know that someone had ordered a
particular thing and it's cost £1000, so you go and ask them why
they needed it and why they ordered it without telling you. You
can't leave these discoveries until the end of the year!

Just one quick note, because it's not obvious to everyone - make
sure that these monthly P&Ls are done on an "accruals basis". Say
that to your accountant or bookkeeper and they will know what you
mean. The accruals basis really just smoothes out lumpy expenditure
that you pay for in one month, but relates to a different month or
more than one month - so your audit fee that relates to last year,
or your insurance that relates to every month of next year, and so
on.

Third, you need to look also at a balance sheet every month as
well. The balance sheet is just a statement showing what you own,
what you owe and what is owed to you. Looking at it every month
will help you to see trends and start to understand how to manage
your cash better. It'll give you early warning of things going
wrong with your customer accounts, your stock management or bank
accounts.

Fourth, if you are not in a cash or retail business, and your
customers normally get invoices and pay later, then you will need
to keep a careful eye on who owes you what and when it is due. So
get yourself a detailed aged debtors list (aged just means it shows
the amounts owed in age categories depending whether they are
current, overdue, very overdue or extremely overdue). I would
advise looking at the aged debtors list on a weekly basis, and
keeping it on your desk. Know absolutely what is due in the next
week and keep asking your accounts people every day whether it has
arrived. This is the foundation of good credit control, and is
critical to making sure you keep enough cash in the business.

Lastly, for now, you need to think about what other information
would be useful on a daily, weekly and monthly basis. Perhaps you
need to track your sales, revenues, order volumes, gross profits,
production quantities or whatever - the point of getting regular
information on how the business is doing is so that you know about
problems and successes as soon as they occur (and not a year
later!).

Remember, trying to manage the performance of a business without
using regular information is like an athlete trying to improve his
performance without timing himself.

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Charis FD is Your Friend in Finance. We help businesses with turnover roughly between £1m and £25m, that have not completely got to grips with the finances. Perhaps they are not making enough money, not generating enough cash, or perhaps the finances are simply disorganised and chaotic. We work with the directors and owners in a flexible and affordable way to take the pain out of managing the finances, so that the business can make more money and be even more successful than it already is.

We work mainly in Hampshire, Thames Valley and Central London at the moment.

If any of the above rings true for your business, we would like to hear from you. Either email us at enquiries@charisfd.com, telling us a bit about your business and your finance challenges, or go to our website www.charisfd.com. On our website you will find lots of information, and also a contact form to get in touch with us.

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That's it for this time.

If you have something that you would like us to write about that would help you in improving the finances of your small business, please let us know...

newsletter@charisfd.com

© Charis Business Consulting Limited 2009

This is the fourth in an 8-part series especially for new subscribers to the Creative Finance & Management email newsletter. Every week we are sending you an article aimed at helping you to think about a different aspect of the financial management of your business. This is in addition to the normal bi-weekly newsletter. We are doing it to give all new subscribers the same orientation to the way that Charis FD thinks about small business performance management. That way we can have confidence that all our subscribers have been given the benefit of foundational advice in all aspects of business performance management.

If you miss any of these articles, don't worry. They are on the Creative Finance & Management blog. Just look for the "New_Subscribers" tag.

These are the articles in the New Subscribers series:

1. The ingredients for success in Finance
2. Strategy and Planning
3. Business Change - implementing your strategic plans
4. Measurement and Management go together
5. Paralysis without analysis
6. Your Finance team - a valued asset
7. Stakeholder management - the importance of keeping people happy
8. Internal Control - 3 fallacies that add risk to your business

Here we go: ...

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Measurement and Management go Together

"What gets measured gets done!" is often quoted as a truism. The other way I would put it is, "if you don't measure it, you don't manage it". What I want to do in this article is show you the principles of how to apply that to managing the performance of your business. You do want to manage the performance of your business, don't you? You know that if you don't manage performance then your business will almost certainly underperform?

I've tried to say in the last three new subscriber newsletters that you have to be intentional in managing business performance, or in managing a business in general. If you want your business to perform well, you have to know and specify what you want it to achieve and have defined strategies for achieving those goals. You should also have given yourself targets for what each of your strategies should achieve.

But you can do all that and still not succeed. One of the main reasons that happens in smaller businesses is that they don't check regularly to see whether they are succeeding or not. They don't measure the outcome of their strategies, or at least not regularly enough. It's no use getting to the end of the year when the auditors come in, or when you sit down with your accountant, to find out that you haven't grown your business as much as you wanted to, or you spent too much. It's a bit late then. You need to measure outcomes monthly, weekly, and daily in some cases.

Getting into the nitty gritty for a minute, the basic financial performance reports you need to have on a monthly basis are the income statement (or "profit and loss account") and the balance sheet.

The income statement should not be in so much detail that you can't see the wood for the trees, but should be in enough detail to see where your money is coming from and where it is going to. For example, if you sell the same small set of products to a few regular customers, then show your income by customer or customer group. On the other hand if you have a varied product set you may want to show your income by product. This depends what your marketing and sales strategies are - segment your income in the same way you segment your sales for strategy purposes. Then you can see if your strategy is making any difference.

Similarly you will want to show your costs in the income statement in a way that makes sense. You may show them by type (e.g. premises, people, insurance, IT, etc) or by department (e.g. operations, sales, finance, IT, HR, etc) or both. It depends how complex your department structure is and how you manage your business.

The balance sheet shows the value of what the business owns, what it owes and what it is owed. It is useful to see particularly the cash balance, the debtors balance (what your customers owe you) and the creditors balance (what you owe suppliers).

But this is just the basic level. Every business should do those without question. You need more. If your strategy is targeting increasing sales, then you must also get more detailed reports on sales. If your sales cycle is less than a month, then perhaps you should be getting sales reports weekly or daily. If your strategy depends on production quantities and operational efficiency, then perhaps you need daily or weekly reports on those things.

And again, don't just look at financial performance. Performance measurement and management are much broader than that. If you are a service business, perhaps you need to measure that utilisation ratios for your consultants (time spent generating revenue divided by time available). If you have a long sales cycle, perhaps you need to get weekly or monthly reports on leads generated and sales pipeline reports. If these things are critical in your strategy to achieve your vision for the business, then you can't manage them properly without measuring how you are doing.

To sum up, what are the key things to think about in performance measurement and reporting? What, how and how often - those are the three key questions. What to measure will depend on your strategy, the things you are doing that are important to getting the business towards achieving its vision. How to measure it will have to be thought through carefully - it could be a figure, a ratio, a traffic light, a pie chart, etc. How often will depend on how often things change. You want to be able to make decisions and adjust your strategy and tactics on the basis of what the information is telling you, so the information has to be timely.

Finally, all this measurement will be worth nothing if you don't use it, if you don't make decisions based on the information. No strategy is perfectly infallible. The information you get may tell you that you are not quite getting it right. If you are learning from the reports you get, you will investigate further and tweak or change your strategy depending on what you find. This the feedback loop complete. The business performance management wheel that I talked about in the first of these articles depends on completing the whole cycle - develop your strategy, carry out your strategy, measure your performance and learn from the information to develop your strategy... and so it goes on.

I'm worried that this all sounds complicated, because I've condensed so much into a short space. If you do a healthcheck on what you actually do at the moment, I think you will find that you already do some of this, but it may be ad hoc, disjointed and disorganised. As with other areas, putting some thought into it and having a rationale for measuring things about your business will get you a long way forward. Just the act of being intentional about performance measurement is big progress.

The final thing I would say is that this is probably one of the areas that someone like a Finance Director would add the most value. They are skilled in pulling numbers together and in interpreting what they mean for the business. If you haven't got anyone like that in your business, then give it some thought. And it doesn't have to be full-time headcount. There are part-time options available, which are more affordable for smaller businesses - one of these options is Charis FD's own services. That's a gentle plug for my business, but I think it's appropriate. See our website for more details.

If you are worried about the cost of such a service or the cost of taking on a full-time FD, think of it in terms of the financial benefits it could bring. They would work alongside you, helping you to put in place the finance and performance management disciplines we have been outlining over the last few weeks. So I would be surprised if following all this advice with help could not help to improve your sales by more than 5%, or improve your gross margins by more than 5-10%, or your net profits by 10% - especially if you have not employed one before (either full-time or part-time). If you look at it that way, it doesn't seem so expensive. That's obviously not making any promises, but it's food for thought!

Why not contact us today?

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Until next time...

If at any stage you want to talk to us, we're quite happy to give you a call to talk more about your business and the challenges you face. And you may be eligible for a free Finance Strategy Review session. To set that up either email us at enquiries@charisfd.com, remembering to leave your phone number and email address; or go to our website and complete the contact form.

Thanks again for subscribing to Creative Finance & Management. We hope you find it helpful.

© Charis Business Consulting Limited 2009