Three Financial Alarm Bells You Can’t Afford to Ignore
Here are………. Three Financial Alarm Bells You Can’t Afford to Ignore if you want to improve profitability in your business.
- Lack of Regular Reports of Key Business Costs and Sales…………..If you are serious about increasing your profits and making more money you have got to know how your biggest and most volatile business costs are running on a regular basis. To control and minimise these key costs your once a year Profit and Loss Account is simply not enough …… If you learn about a problem with your gross profit percentage, your wages cost level or your cost of goods sold percentage from your annual Profit and Loss account, how much time has already slipped by without action being taken,….. how much money has already been lost that should have gone to bottom line profit. Often the annual Profit and Loss Account will not be available until half way through the following financial year. So the problem could have existed for up to 18 months unnecessarily bleeding valuable profit out of the business for all that time.
Think of all the money you could have lost over all those months. If you know what your key controllable costs are on a regular basis during the year, then when something is out of line you’re in a much better position to react quickly and get the problem solved before any more money is needlessly lost.
By key controllable costs I mean wages costs, cost of goods for resale and any other really significant cost categories..
For many businesses pre tax profit margins are often in the range, 4% to 8% of sales, so there is little room for error when it comes to financial management. “ Cost of Sales “ plus Wages Costs generally account for far and away the bulk of readily controllable costs in most businesses. The combined total of these two cost categories is where the battle for business profitability really has to be waged. This is not simply because they represent the largest percentage of costs in your business but, vitally important…. you have the opportunity to control them !.
Unlike Rent,Rates or Insurance costs which are relatively fixed, you can take prompt action to directly impact your Cost of Sales. Similarly staff hiring practices, staff scheduling and overtime policy can favourably impact your wages cost. Please hear me loud and clear !….if your Cost of Sales plus your Wages Costs are not tightly controlled it’s going to be very difficult if not impossible to achieve an acceptable level of profitability in your business.
Large companies produce a Profit and Loss Account on a monthly basis, sales levels and individual cost categories are then carefully compared both against budgets and against the same month in the previous year. Any areas giving cause for concern are then carefully investigated and corrective action taken as quickly as possible.
If you really are serious about improving the profitability of your business knowing where you stand on a regular basis throughout the year will definitely help. You should seriously consider following the example of large companies by having regular profitability reports prepared at least on a quarterly basis. Most importantly study those profitability reports and take corrective action fast where necessary. It will be well worth the effort when you see the improvement in your bottom line profitability.
2. Absence of an Organised Accounting and Bookkeeping System…………You cannot manage what you cannot measure !. A business whose accounting and bookkeeping system is not properly structured and regularly maintained up to date often results in the owner “ flying blind “ from a financial point of view. Since the other “ Red Flags “ discussed in this post cannot be accurately identified or evaluated if the accounting system is not properly set up and maintained this task should be a key priority for the business owner if he or she is determined to improve profitability and create a prosperous business for the long term. Ideally the accounting system should be planned and set up before the business opens. However if your business is already trading and you suspect that your accounting system is in need of some “ first aid “ then you need to get some help as soon as possible. I have rarely seen a truly successful business that did not have its accounting and financial controls in good order and regularly maintained up to date.
When I am evaluating the financial health of a business I would want to know if regular accounting reports of sales, detailed costs and profitability are provided to the owner. I would also want to know how the financial transactions are entered into the accounting system. I recommend setting up the “ chart of accounts “ for the accounting system to reflect industry standards, that way it is possible to compare the operating results of the business against others in the same industry.
The objective has to be to set up and maintain an accurate accounting and bookkeeping system which can produce relevant financial reports which permit proactive day to day management of profitability and cash flow within the business.
there are several very adequate accounting packages on the market. My own preference is the Xero cloud accounting package. It is very inexpensive, very user friendly and quite simply does the ob to a high standard.
- Lack of Organised Cash Flow Planning and Management……….Many business owners are just too busy fire fighting and dealing with today’s priorities to have the time to adequately plan and manage cash flow on an ongoing basis. A company’s cash flow is its lifeblood. Without an adequate and steady cash stream flowing in and out the very survival of a business can be put seriously at risk. In today’s business climate money is tight, banks often don’t want to lend and cash is king…. so it’s more important than ever to plan ahead to make sure that your business will not suffer a “ cash flow crunch “.
The key to warding off cash flow problems is to project forward your cash flow needs by building a cash flow plan. Here are some strategies that will help you to manage the flow of “cash in” and “cash out” of your business so that you don’t get caught in a cash crunch.
- Forecast Your Cash Flow For The Months Ahead
Study your customers paying habits, especially the habits of your biggest customers. In this way you can predict when and roughly how much they will pay. Here is a tip….the amount you forecast needs to be within 5% of the amount you actually receive for the month in question. If your predictions are way off the mark then your customers are possibly slowing down the payments they make to conserve their own cash flow…………………….and a cash flow problem may soon be looming for your business ( fore warned is fore armed ).
Similarly you will need to forecast reasonably accurately the expenses you will need to pay out on a month to month basis.
- Establish a Trade Debtors Receivable Process
You will improve your chances of cutting your “ Outstanding Debtor Days “ if you : –
Generate and issue sales invoices with the minimum of delay after the sale is complete……
Record sales invoices in the business ledgers promptly……
Issue statements to your customers of outstanding balances promptly and in accordance with a planned timescale.
You need to have a clear procedure that you apply consistently to ensure that “ overdue “ outstanding debtor balances are tracked and effectively pursued and collected.
- Track and Monitor Business Expenses
On a regular basis you will need to compare the expenses you actually paid out with the forecasts of expenses you previously made. This will help you identify and anticipate any additional need for cash and react quickly. For example, if an unavoidable and unforeseen cost has been incurred you will have an early warning of how this is going to impact your bank balance and gain some valuable breathing space to decide how to respond by perhaps cutting costs in other areas.
- Project Sales Levels for the Coming Months
It’s important to base your sales projections on facts. A good starting point is to take sales for the same month last year. Then consider what has impacted your business since that time, e.g. customers won and lost or perhaps the impact of any increase/decrease in selling prices you have implemented. Basically use past experience to help you predict future sales levels. Also talk to your customers to get an idea of their likely buying patterns in the months ahead.
Even after you have projected your sales you will need to monitor the actual sales levels achieved. If actual sales dip below your projections the sooner you make adjustments……cut expenses, reduce stock levels or borrow money to tide you over….the better. For many companies it’s normal to experience peak trading periods and also quieter periods during the year which will result in cash flow fluctuations that you as the business owner will need to manage. To cope with the quieter trading periods you need to be able to anticipate when your sales are likely to drop. Then make sure there is some cash put aside to cover expenses in these lean months.
The Xero cloud accounting package is a fantastic and inexpensive tool to help you monitor and control the cash flow in your business and I strongly recommend you to give it serious consideration for your business. If you don’t think you are going to have the time to carefully and regularly manage business cash flow get some good professional help, it will make sound financial sense in the longer run.