How good are you at managing your business finances

How good are you at managing your business finances

Having provided part-time controller services to many businesses over the years, I have noticed that, while the level of financial management in businesses varies from business to business, there are a number of broad categories that could be applied to a business’s financial capability.

No Financial Management

With the least capable businesses, financial management is ignored. Documentation is gathered up during the year and given to the year end accountant in order to prepare annual accounts and tax returns.

In this scenario, the management effectively run the business with reference to the bank statements and are frequently surprised by the actual results when they get them. You have no financial systems, paper or computerised. You often pay VAT and PAYE estimates during the year and balance them up at year end.

The problems this causes is that you get lots of surprises.  You will not know how you are doing until your external accountant does your accounts at year end.  You seem to be constantly blindsided.  You could be losing money.  You are likely to get caught with  bills that your were not expecting.  Living in this sort of environment is stressful.  You probably find it hard to sleep at night.

If I was advising you, I would start by getting you to put in some systems, preferably computerised, so that you  would capture basic information on sales, purchases, cash in and out.  You know at any point in time how much you sold, how much you bought, who owes you money, who you owe money to and you would know how much VAT and paye are owing.

Basic Financial Management

In this next group are companies who have a book-keeper, either internally or outsourced, and have some sort of book-keeping system – most likely computerised but it could also be paper based.

These companies record purchases, sales and cash transactions. You process payroll during the year and prepare and submit their own VAT returns.

Usually, the only accounts that you get are the annual accounts from the accountant.  You will have some idea of how you are doing as you will be able to get sales reports and some cost reports during the year.

Your business is  likely to get surprises when you receive the year end accounts.

I started referring to this level of financial management as “No Offences” as they comply with the legal requirements only.

The problem here is that you have little or no visiblity as to why you are getting the results that you are getting.  You are making decisions based on instinct rather than facts.

If I was advising you, I would put in place monthly routines so that you firstly check that the numbers in the system are reliable.  Then I would set up a process to identify any adjustments that are needed to get accurate profit figures.  Also, I would identify key reports and have your bookkeeper start to give you a monthly financial reporting pack.

I started referring to this level of financial management as “No Offences” as they comply with the legal requirements only.

Integrated Financial Management

As we go further up the capability ladder, your business will have either internal or outsourced resources who will prepare management accounts for you. They usually analyse sales and costs so as to get some meaningful information. They may do stocktakes during the year or, if not doing a full stock take, they will generate an informed estimate of the stock levels.

If this is your business you will usually have computerised financial systems but these may not be integrated with operations systems.
You usually prepare an annual budget and, in the management accounts, actual results are compared to budget figures. You will be investigating differences and in this way your are building up your understanding of how your business work and what affects the profitiabilty and cashflows of the business.

The business will also use that budget to generate costs for their budgets or services.

On a monthly basis, management will review these management accounts and will refer to them when making significant business decisions.

I started referring to this level of financial management as “No Surprises” as they have a reasonable sense of the financial results as they go through the year and when they get the annual accounts, the results tend not to be a surprise.

If I was advising you, I would be double-checking that you are focussing on the key performance measures.  I would be very focussed on understanding why your results are varying from what you expected.  I would be drilling down into the numbers to know how profitable each product is.  I would be also looking ahead to see what is happening with cash and to make sure that we don’t hit any problems.

Strategic Financial Management

The highest level of financial management capability that I come across is what I call Strategic Financial Management. In this scenario, your business will regularly prepare a long range business plan which will include financial projections. The financial projections will comprise profit and loss, balance sheet and cash flows.

If this is your business, you  will usually has a full time or part-time financial controller who will provide financial inputs and interpretation and analysis to the management team and also provide guidance and direction to the accounting staff.

The projected financial statements will be consistent with each other and will allow for sensitivity analysis ie testing what might happen to profit and cash if a key input varies.

The projections will be updated regularly – at least annually, but often quarterly or every four months.
These businesses can anticipate cash squeezes and funding needs and will take action to address these before they cause problems for the business. They also know which products or services are generating profits and which are not.

Also, they  usually have financial systems that are integrated with the Operations systems so that they have very good insights into how operations are driving the financial results.

I refer to these businesses as “No Regrets”.  You know that you have a good business and you make every effort to ensure that the business achieves it’s potential. In years to come, when you look back, you can feel confident that you gave it your best shot and you have “no regrets”.

If I was advising you, I would be making sure that you keep doing what you have been doing.  I would be looking for the further improvement – better analyis, faster reporting, reducing the work involved to get the information.  I would expect to be spending more time with you looking ahead – evaluating opportunities and assessing the impact on profitability of any changes that are coming.

Over to you?

Where do you think you fit into this classification?

If you want to improve your financial management and need help, feel free to call me or drop me an email. With a small bit of information about your business, I will be able to assess the level where you are, identify some improvements and help you  implement these.

Using your accounts to manage your business

Hello,
Do you ever wonder how some businesses are able to use their accounts to help them manage and improve profitability?  In this short video, I will give you an approach that will change how you think about, and how you use, your accounts.

I’m Jim Cahill of AccountsPLUS. I provide CFO/FD services to Engineering and Construction companies.

PDSA

You may have heard of the idea of a feedback loop, sometimes called the engineers feedback loop.

In Lean and Business Improvement Circles its called PDSA which gives a better idea of what its about.   PDSA stands for Plan Do Study Act.

When using PDSA you start by making a plan for what you want to achieve – that’s the P.

They you carry out the plan by doing something – that’s the D.

On completion of your work, you study what happened – that’s the S. In studying you want to find out if you got the results you expected and if not why not.

Finally, armed with the knowledge that you have gained, you act – the A. You use the information to make changes – either in your plan or in how you are executing the plan.

So now you can see why it’s a feedback loop and by using this in your business you learn about what’s working and what doesn’t work and you apply that knowledge.

Linking PDSA to Accounts

So how does that tie back to accounts.

At the start of a period, usually a year but it can be some other period, you create a financial plan for the period. This is your P. I have a separate article on planning or budgeting.

Then you operate the business – executing the plan – this is your D.

Next step, you get management accounts – this is the feedback from your business – and you study these. This is the S. I have another article on designing your accounts to get good information.
Were your assumptions correct? Did you get the results you expected? If not, why not? So you develop your understanding of what’s happening in your business.

Finally, you make decisions about what actions, if any, you need to take and you take those actions – your A. I also have an article on carrying out improvement projects.

In order for the above steps to work, you need to have regular and reliable management accounts. These accounts should be designed to provide you with analysis that will help you analyze your performance.

Conclusion

That’s the sort of work that I do. Helping clients identify what they need from their accounts and putting in place the procedures that will give the information and finally helping them analyze the results and implement the improvement strategies.

If you feel this would be of benefit to you, feel free to contact me by phone 086 2323525 or email jim@accountsplus.ie.

I hope this was helpful and thanks for watching.

 

Making the best business decisions – how to evaluate your opportunities

One of the questions that I get asked most often by business owners is how to decide between one or more options – when faced with path A or B, how do you know which fork to choose and what the potential outcome may be?

These sorts of question arise for businesses of all sizes and they’re just as important for the small business owner as for the large business owner. In the past three months, I’ve helped a painter/decorator decide if he should change his van and I’ve helped a large food manufacturer decide whether to outsource production, or keep it in house. For both of them, their decision was important and could have an impact on their business.

The value of good advice

I wasn’t long qualified as an accountant when an old school friend, now a dentist, asked me if he should refurbish his dental surgery. He’d already asked his accountant, who replied “that’s up to you”. That answer wasn’t very helpful. We know it was up to him to decide but his accountant wasn’t providing him with any advice as to how to make that decision.

To put it bluntly, he wasn’t adding much additional value as an accountant.

But (thankfully) times have changed, and most good accountants now realise that a large part of their role it to help with this kind of decision making – whether it’s supplying the right numbers, forecasting the potential outcomes or looking at the strategic implications.

So how do I go about making financial decisions?

I focus on the cash flows in your business and compare the different cash flow relating to all the options.

The simplest way to explain my approach is to imagine that the business has a large barrel of cash and ask what will happen to the cash in each of the scenarios. What money will come in and what money will go out? Once I identify the cash flows, I enter them into a table with three columns.

  • The first column is for the cash flows in the current situation.
  • The third column is for the cash flows in the alternative situation.
  • The middle column is for the difference in cash flow between the two options (I’ll show you an example of a completed table shortly).

Before you do that, you need to decide what sort of a time period you’re going to consider.  Its common to look at a decision over the life of the relevant item – so if it’s a van and you plan on changing again in three years, then you might evaluate it over three years. If you’re looking at outsourcing production, you might just look first at one year and then consider whether you need to review a longer period.

So, let’s look at the van example.

How much will a new van cost?

Let’s say John is currently running an 8-year-old van. His garage has a good 3-year-old van for €12,000 and will give him €1,500 for the old one. John wants to know if he should change.

The first thing I will ask is what the current van is costing him. He tells me his current van works up the following costs:

  • €3,600 a year in diesel to fuel the van.
  • €300 a year to tax and €500 a year to insure it.
  • Repair costs as the van had been giving him trouble which needed repair
  • €100 per day to hire a replacement van while his own was off the road – he expects this to continue and suggests that I allow 5 days a year for being off the road with maintenance work.
  • 2 days a year in lost earnings while he is dealing with the van – where he normally earns €400 per day on average.
  • Overall the van is costing John about €2,000 a year in maintenance, €1,000 of which is normal wear and tear, the other €1,000 is due to breakdowns.

Next, let’s look at the costs of buying a new van:

  • The new van John has his eye on will cost €12,000
  • We can then subtract the €1,500 trade-in on the old van.
  • John reckons he’ll sell the van on in 3 years for €4,000.
  • He estimates that it will cost him about €3,100 a year in diesel.
  • It will cost him €250 a year to tax it but €600 a year to insure it.
  • He’s not expecting to have any breakdown days or van hire.

So, overall the new van should cost about €1,000 a year in maintenance, which is all for normal wear and tear.

Note – these are not real numbers. They’re my best guesses to develop a reasonable example for you.

I put my table together, taking three years into account.

Current Van Difference New Van Comment
Investment 0 -10,500 -10,500 As I’m only looking at what will happen from now, I don’t consider the cost of the current van.
Fuel -10,800 1,500 -9,300 This is fuel cost over 3 years, based on the info supplied.
Maintenance -6,000 3,000 -3,000 Maintenance cost over 3 years. based on the info supplied.
Van Hire -1,500 1,500 0 5 days pa for 3 years at 100 per day
Lost Earnings -2,400 2,400 0 2 days a year for 3 years at 400 per day
Tax -900 150 -750 Info as supplied
Insurance -1,500 -300 -1,800 Info as supplied
Resale Value 0 4,000 4,000 Info as supplied
Net Cash In/(Out) -23,100 1,850 -21,350  

 

Positives in the cash flows are ‘cash in’ and negatives are ‘cash out’. In the difference column, positives show where the new option is better than the current option; i.e. cash in, or less cash out.

So, what the above table tells us is that a new van looks like it will save about €1,850 over the three years. We need to be careful and remember that we’re making assumptions, albeit reasonable ones, about the performance and reliability of the new van. We need to be confident that we are aware of, and considering all of, the costs.

We’re not taking into account intangible elements like the effect on his business profile of driving in a newer van. Also, we’re not taking into account the effect on customers of cancelling work because the van let him down. And we’re also not taking into account the effect of having a reliable van and less stress and worry on John himself. We can allow for those in our decision but it’s hard to quantify them and put them in the table.

The bottom line is that the new van looks like it will save him €1,850 over the three years but there are some intangibles that might also be worth a lot to John and only he can put a value on those. I think most of us would change the van based on the info above.

The time value of money

Another factor to take into account is what accountants call the ‘time value of money’.

If I ask you which would you prefer – €1,000 now or €1,000 in 1 year – you’ll all intuitively know that if I get €1,000 now I could invest it somewhere and maybe make another €10 to €30, say €20, in that year. That means that €1,000 now is really worth €1,020 in 1 year. This is what we call the time value of money.

For some decisions, it can be worth taking this time value of money into account.  If you have high interest rates and two options with very different cash flow patterns then it may be worth looking at. But for most day-to-day investments, it’s not worth the additional work – and in any event it will involve other assumptions.

A systematic approach to decision-making

So, that’s how I recommend that you approach decision-making – by systematically breaking down those cash flows and seeing which scenario works out best for your business.

  • Identify the options available to you.
  • Note down the cash flows for each option.
  • Put them into a table and see which one looks best.

Put a little bit of time into challenging your assumptions and into thinking through the options to make sure you have considered everything that is relevant. And armed with your outputs you can be confident you’re making the best decision for the future.

Next time we’ll look at some more practical examples of how this can be put into practise.

If you’d like any assistance with your business decision-making, please do get in touch to see how we can help