Business owners go through phases in their attitude to managing the finances of their business. Initially there is more concern about getting work in to survive. At some point the connection between the finances and the business either clicks and they want to understand it better — or they conclude it's too complicated and leave it to someone else.
One of the most financially challenging sectors is construction. Payments are made after work is completed and subject to valuation under the contract, which can cause delays. The value of work tends to represent a large expenditure for clients, so they tender the work, which means low margins for the provider. Where there are such pressures, there needs to be a good understanding of the numbers — otherwise the business will run out of cash.
The Five Chapters of Financial Management
There are five areas of financial management that stand out for SMEs:
- Forecasting — without a forecast you cannot compare what you thought would happen against what actually happened. Unpleasant surprises at year-end become almost inevitable without one.
- Cash flow — cash is the lifeline of a business. It enables you to pay bills and continue trading. Without it, the business will die. Having access to enough cash to meet your immediate needs is vital.
- Profit — business owners of small businesses generally check that income is greater than outgoings. But how well the business is really doing can be disguised by tax arrangements. It is worth being hard on yourself and checking whether the profit is really adequate for the risks you are taking compared to being employed. Analysis of gross profit from operations can be used to manage the portfolio of work, reward staff, and determine if different geographic areas are performing differently.
- Investment — when a business makes a profit, some is taken by the shareholders and the remainder retained or invested to allow more work to be carried out. If you are confident the business will grow and the figures tell the right story, you can borrow money to speed up growth and repay the loan from business activities.
- Review and action — forecasting, investing, and managing day-to-day payments all have different time horizons. The easiest approach is to have a general long-term goal, break it down into targets, and monitor against those. Typical time horizons used to manage a business are: 3–5 year plan, annual, quarterly, monthly, weekly, and daily.
Conclusion
Obtaining the story from the numbers is known as the management accounts. They are done in far more detail than the financial accounts your accountant prepares for compliance. There is a saying: turnover from sales is vanity, profit is sanity, but cash is king. For the majority of SMEs, getting to grips with these five aspects of financial management will help retain that sanity and make running the business less stressful.
