The five golden rules of financial management
SMEs often have the wrong idea about financial management.
It’s either something their accountant takes care of, or a complex maze of information that’s like speaking another language that’s too hard to learn.
In reality, financial management is one of the most important elements of managing your business. Financial management allows you to have the right information at the right time, in order to make the right decisions.
With a little education and the right resources, you can achieve this and it will make all the difference to your business performance and personal wealth as a result.
Here are my five golden rules of financial management every business owner should know:
1. You can’t be successful without strong financial management
According to Dunn & Bradstreet, more than 80% of small business failures in Australia are the result of bad financial management – poor cash flow, debtors out of control, lack of focus on profit margins, and overtrading beyond your business’s ability to meet commitments.
All of these issues can be overcome simply by implementing the right financial management systems and processes.
I have never seen a successful business that does not have strong financial management.
However, even when it’s your business, you can’t know and do it all. So, if crunching the numbers is not your strength, either hire or outsource to someone who is an expert, then make sure they deliver frequent and reliable information and advice that you can use to manage your business and financial position.
2. You can’t manage what you don’t measure
While I’m a believer that gut instinct is sometimes valuable, having your results in black and white is hard to argue with. Deciding what to measure is the most important first step in this process.
You can measure just about anything, so get focused on what matters to you most. What’s your biggest challenge right now? What keeps you up at night?
If it’s sales then focus on lead generation, conversions and purchase value. If it’s cashflow, then collection days, turnaround time on issuing invoices or the amount of time sales staff spend explaining payment terms might be important.
Or maybe the most important feature for your customers is speed of delivery; so productivity, assembly, shipping and accurate completion of order forms is important to measure.
Once you’ve decided what to measure, make sure you give adequate thought to how you measure and use the information.
3. It’s about cause and effect - make sure you measure and monitor causes as well as effects
Measuring the outcome or end result is not enough. There’s no use looking at your sales figures and profit and loss statement at the end of the year, wishing you could have made more money.
These results are lag indicators that show you the effect of what happened during the year. They are already history.
If you want to be able to make more money and improve what’s happening during the year, you also need to monitor lead indicators or the activities that cause you to achieve the results.
Monitoring your lead indicators enables you to see what’s happening closer to real time, allowing you to see patterns, trends and make predictions about the results you’re going to get.
You can use those predictions to make decisions about whether to make adjustments to enable you to generate more sales, service your customers better or manage your resources.
Examples of lead indicators are the number of leads, customers that come into your store or sales appointments you make in a week.
The more leads, customers and appointments you have, the more sales you’re likely to achieve. If you’re in a service-based business, the number of jobs booked in is a lead indicator of sales or fees you’ll generate as a result.
If you track the relationship between lead and lag indicators, you can easily see mid-month if you’re not generating enough store traffic or booking enough appointments to result in the sales you need to achieve.
With this knowledge, you can double your efforts to improve the lead indicators and make sure you achieve the results.
4. It’s all relative - compare, compare, compare
All of this is about achieving better results, building a better business and realising a better financial result. It’s the natural state of a business to grow.
It’s also natural for a business owner to want their wealth to grow. To do this you need a comparison or reference point from where you were versus where you are now and more importantly where you want to get to.
That comparison could come from benchmarking against others in your industry or best performers in business regardless of which industry they come from. There’s nothing like a bit of healthy competition to spur you on to become even greater than you already are.
Or you could focus inwardly and compare your own business performance against monthly budgets you set for the year, or by comparing your whole year financial results against the prior year.
Failing to do these internal comparisons means you have no clear sense of how things are progressing or even knowing if you are in fact progressing or actually going backwards.
On a finer level, comparing your performance and results, helps you to uncover variances and patterns.
You can use this information to understand the negative impacts you need to put measures in place to prevent occurring again, or to spot opportunities you can capitalise on.
Once again, if identifying and interpreting financials isn’t your strong point, make sure you have someone on your team, whether employed or outsourced, that can help you do this.
5. Keep it simple
This probably sums up why a lot of business owners don’t have the right financial management approach to suit their business. At some point it sounded or became too hard, complicated and over-engineered.
There are so many systems you can choose and numbers you can gaze at and measure, without gaining any real understanding. Paralysis by analysis becomes the end result.
The key is don’t get caught out and confused on the fly when a problem arises and you’re struggling to understand what went wrong.
Invest a little time when you’re starting the business to implement the right financial management solutions for you, and then tweak it every year after that to make sure it stays relevant to your business and to you as its owner with the highest financial expectations and vested interest.
Marc Peskett is a director of MPR Group a Melbourne based business that provides business advisory, capital raising, grants services, as well as tax, outsourced accounting, finance lending and wealth management to fast growing small to medium enterprises. MPR Group is a member of the Proactive Accountants Network. You can follow Marc on Twitter @mpeskett