By Iqbal Thokan
Knowing what the numbers are, is good. Knowing how to understand them to make an informed decision is even better.
Having our business finances in order allows us to gain insight into the health of the business at a particular moment in time. Whether it is our monthly income statement or our quarterly balance sheet, the financial management of our business is important.
As business owners our ultimate aim is to get a return on investment better than any other investment we can make, otherwise, why do we slog and sweat when it is easier to invest our money into something that gives us better returns.
The value of our returns is basically made up of two objectives, how well we manage the operational variables in our business, income and costs and how well we circulate our limited resources, the capital and its movement through the business. A high net profit with a large number of circulations gives us a good return on investment.
However, managing our operations well and getting a good circulation of funds requires us to monitor our finances very closely so that we can make informed, efficient and effective decisions. This requires us to use certain financial tools.
A good way to manage your financial tools is by having a good accountant, however, while the accountant is able to give us the numbers we need to be able to analyse them using information that we have from the internal as well as the external landscape of our businesses.
While many of our businesses have financial reporting systems from point of sales to more integrated systems including great accountants, we often overlook them. The true potential of these resources lay in their use to analyse our business and should be viewed as assets of control.
Even a simple tool such as recording our daily sales in a book can be developed in to a very useful analysis mechanism for the day or month and allows us to track the data giving us valuable information such as seasonality and trends. While many of us have great accountants we sometimes tend to rely on their better judgement to make decisions for us. A great accountant is a great asset and a worthy investment but unless they are embedded within our business their decision-making capabilities are limited to the amount of information we give them.
Let’s put this into perspective with an example, let’s say on average our gross profit margin is 55% and in one month we drop to 45%. Our accountant might be able to bring this to our attention but without knowing the landscape and the reasoning for this we will not know why this has happened and most probably make the wrong business decision. As we know our gross profit margin is determined and can be impacted by several factors the first of course is sales, the second is cost of sales, which can be further broken down into how well we purchase and how well we manage the stock of our business. Now the drop in our gross profit could either mean that our sales dropped or our cost of sales increased. Let’s assume that our cost of sales was the factor and that it increased. Now as we know this could be for two reasons, there’s a problem with our stock or our purchases increased. The question we then have is, is the drop on gross profit a good thing or a bad thing? The general answer is that it is bad, however, the fact is that we can only answer this based on context. And context can only be defined through the information we have at hand. For example, we could have bought extra stock as we anticipated an increase in sales or our supplier was willing to give us a great discount on a bulk purchase, which would then mean that the drop in gross profit was not necessarily a bad thing.
Making the right informed decision within our business requires us to have the right financial tools in place, but it also requires us to have to the right information about what is happening internally in our business as well as externally.
Recently, I have been working with a wonderful client of mine, who, with great tenacity and determination had built his business from the ground with a very minimum cash injection which was all that he had at the time. Taking the risk and working long, hard and tedious hours he managed to build his business into a multi-million rand one in just over 10 years.
His biggest challenge was that he relied heavily on his sales system to give him his numbers and didn’t have any other financial tools in place to analyse the business. Over a short period, the business started declining and he couldn’t analyse the reasons for this to make the right and informed decision. Working with him we have started to develop the right financial tools to feed into his dashboard and having seeing the benefit of using these tools he is now able to make better informed decisions that allow him to survive.Financial tools with operational knowledge, industry knowledge as well as the market knowledge allows us to stay relevant, survive and thrive.
Iqbal Thokan is an experienced business management consultant and the founder and co-owner of breedingpositivity.com
Why Business Finance Is Important
Businesses run on money, and business finance guides you to make shrewd and prudent decisions about cash flow and longer-term funding strategies. As you develop skills and strategies for using the funds you have and for accessing additional capital when needed, you’ll improve your company’s profitability and increase your potential for leveraging new opportunities.
Business Finance and Management Accounting
The way business finance functions in an organization depends on management accounting reports. These documents should be current and accurate enough for your finance department to find them relevant and useful. There are three reports you should be looking at: the profit and loss statement, balance sheet and cash flow statement.
Reading a Profit and Loss Report
Your profit and loss report, or income statement, provides information about how much your company has earned or lost during the statement’s period. Net profit (or loss) is calculated by subtracting total expenditures such as rent, materials and payroll from total revenue, which is also broken down by categories such as wholesale and retail.
A profit and loss statement is relevant to business finance because it shows whether your company can reasonably handle new expenses, such as investments in equipment or property. However, just because your business shows a net profit on its income statement doesn’t mean you’ll have the cash you need to pay off loans or buy new equipment. Some outgoing expenditures, such as payments on loan principal, use up available cash without appearing on your profit and loss as expenses.
Despite these discrepancies, if your income statement shows a trend toward profitability over time, you’ll have greater potential for successfully paying off debt than if your income statement shows that your company has consistently lost money.
Reading a Balance Sheet
Your balance sheet provides information about how much you own and how much you owe. It is a snapshot of your overall financial picture at a moment in time. Balance sheet figures are useful for business finance because they show whether your company’s level of debt is sustainable or whether you owe too much already, and it would be more advantageous for you to hold back on a major purchase you’re considering.
By summarizing your assets and liabilities, a balance sheet can also give you a picture of the fluidity of your assets. Money in bank accounts is useful and available, while money tied up in inventory or equipment cannot be easily accessed.
Reading a Cash Flow Statement
A pro forma cash flow statement shows your anticipated incoming capital and outgoing expenditures over a period of time, such as a year, broken down month by month. While a profit and loss statement shows your earnings, which may show some discrepancies from your actual cash on hand because of accounting conventions, a cash flow statement specifically addresses the availability or shortage of cash.
This makes it especially relevant and useful to your finance department. However, a cash flow pro forma is still a projection. It will almost never exactly correspond with your actual financial picture. Its speculative nature makes it somewhat less useful for making financing decisions.
Sources of Finance
In a perfect world, your business would always have enough money coming in from sales of goods and services to pay for daily operations. In the real world, most businesses need some kind of funding to cover short-term expenses, which don’t always correspond with incoming revenue streams. Your business may be seasonal, earning enough money over a couple of months to cover long periods during the rest of the year when you operate at a loss. Or your business may be very busy late in the month or late in the week, but you still need to make ends meet during the slower times.
Financing for working capital is easier to obtain than financing for major purchases and investments. Many banks offer unsecured credit cards and business credit lines. You can use these options to cover business expenses without staking personal collateral or filling out long loan applications requiring extensive documentation. However, interest rates for unsecured financing options tend to be considerably higher than for business-lending products that are harder to obtain, such as secured term loans. Because of these high interest rates on credit cards and credit lines, it’s prudent to use these loan products only for short-term needs and to pay off balances as soon as possible.
Sources of Finance and Working Capital
Business finance is important when evaluating working capital financing because it gives you the tools and information to assess how much money you need and the best way to get it. If your company operates with a monthly cycle where it accrues most of its expenses early in the month and earns most of its income later in the month, a high-interest credit card isn’t such a bad option. You’ll pay the money back quickly, so you won’t be seriously hurt by the interest rate.
If your business operates at a loss from January until Thanksgiving and then earns enough in December to offset these losses, it’s worth doing extra research and paperwork to secure a lower-interest credit option because you’ll be paying interest for a longer period of time.
Business Finance and Capital Investments
When your business makes purchases of equipment or property with lasting value, finance comes into play as you evaluate whether you’re ready for the expense and then find the best way to pay for it. It is common for long-term capital investments to require loans, so you’ll need to consider interest expense and principal payments. Your business needs to earn enough to cover these upcoming expenditures.
A cash flow pro forma is an indispensable tool for forecasting and planning. You can plug in the amounts of anticipated principal and interest amounts and also tinker with other variables to find ways of making these extra payments. For example, if you’re investing in a piece of equipment that will reduce labor costs, your pro forma will show how far these savings in labor will go toward meeting the payments on the equipment.
Making Capital Purchases
When you’re making capital investment purchases, you’ll also use business finance to weigh the pros and cons of different repayment options. Let’s say you have a choice between a lower-interest loan with a high monthly payment and a quick repayment period versus a higher-interest option with lower monthly payments over a longer period of time. Of course, a lower-interest option is the best option, provided you have the cash flow to pay for it. But if your cash flow is tight and the equipment upgrade will save you enough money to cover some added interest, you may actually decide that the option with higher interest and a lower monthly payment is better. Lower payments help cash flow, and good cash flow puts you in a position to take advantage of opportunities.
There is no set, reliable formula for evaluating all the costs and benefits of a long-term financing option. However, if you consider all the ways that a purchase will affect your income and expenses, you’ll probably make a better decision than if you focus on the interest rate alone.
Another variable that will affect the long-term costs and benefits of a purchase is the value of the money you spend and the way it changes due to inflation. When you make a loan payment in the future, you’ll use capital that is worth less than the capital you borrowed because inflation decreases the value of money over time. Accountants and finance professionals use a formula called “return on investment” to calculate all of the quantifiable benefits that an investment will bring in over time and then compare these benefits with the total cost.
The Role of Depreciation
Finance decisions for major capital improvements should also take depreciation into account. When you make a large investment, such as a van, computer or building, your business must follow a set of tax conventions for reporting the purchase. The way you log this expense into your bookkeeping system has ramifications for your income and cash flow. Instead of being able to deduct the entire cost of the major asset in the year you bought it, you are required to declare a period of time for that asset’s useful life and then deduct a percentage of its initial cost during each subsequent year.
The IRS stipulates specific depreciation periods for certain types of equipment, such as vehicles and computers. Other investments, such as lease hold improvements, come with more leeway. The depreciation period you choose affects your tax liability. The more quickly you can depreciate an item, the more of its cost you can deduct each year, decreasing the taxable income that you report to the IRS. It’s prudent to speak to a tax professional before making decisions about how to depreciate an especially large purchase, such as a building.
Business Finance and Retained Earnings
The term “finance” is used as a noun describing the process of managing your company’s money, but it is also used as a verb meaning to secure capital from an outside source through a loan or investment. Despite this association with borrowing, you can also use business finance to manage the funds you have available from regular business activities, such as sales of products or services or rent on property you own.
These retained earnings are an appealing source of operating or investment capital because you don’t have to pay interest on them. You also don’t have to convince a banker or investor that your project is worthwhile, and you don’t have to do all the paperwork required for a loan application.
Beware Opportunity Losses
If you rely exclusively on retained earnings for short-term cash flow and longer-term investments, you may lose out on opportunities you could have leveraged if you’d had more money available. You may get a lucrative order that requires more of a capital outlay than you can make with your available cash. The cost of losing the business can be higher than the interest you would have paid if you borrowed the money. Similarly, if you own a retail location and you’re keeping strictly to a cash budget, you may be unable to buy enough inventory to offer enough of a selection to lure potential customers.
A finance strategy of working primarily or strictly with capital from retained earnings is a prudent approach, but it can also make you overly cautious. You may hesitate to buy a piece of equipment you need because you don’t have the cash on hand, but you would have saved more in labor over time than you would have spent on the equipment. It’s a good idea to use retained earnings whenever you can do so comfortably, but line up backup sources of financing so your business doesn’t suffer on the occasions when your available capital just isn’t enough to make a smart move or to recover from an emergency.
It takes money to make money, so the proverbial saying goes. Businesses have to consider their finances for so many purposes, ranging from survival in bad times to bolstering the next success in good ones. How you finance your business can affect your ability to employ staff, purchase goods, acquire licenses, expand and develop. While finances are not necessarily as important as vision and a great product, they are crucial to making the good stuff happen.
Starting Capital and Financing
Every new venture needs seed money. Entrepreneurs only have dreams and ideas until they have some capital to put their ideas in motion. Whether it’s a product or service, you will need a way to create and deliver it – as well as enough money and time to lay the groundwork of selling and establishing important relationships. Most business owners face the critical choice between debt and equity financing.
A small business loan leaves you free to own and have absolute control over your company while it also leaves you lasting financial obligations. Equity gives you cash, but you have to share the success. The critical decision in your financing will determine how your business will work from that point onward.
Importance of Debt Ratios
Finances are about more than money in your hand. While most businesses have some amount of debt – especially in the beginning stages – too much debt compared with revenues and assets can leave your with more problems than making your loan payments. Vendors and suppliers often run credit checks and may limit what you can buy on credit or keep tight payment terms. Debt ratios can affect your ability to attract investors including venture capital firms and to acquire or lease commercial space.
Weathering Business Cycles
No matter how well your business is doing, you have to prepare for rainy days and even storms. Business and economic cycles bring dark clouds you can’t predict. That’s why smart businesses create financial plans for downturns. Cash savings, good credit, smart investments, and favorable supply and real estate arrangements can help a business stay afloat or even maintain momentum when the business climate is unfavorable.
Opportunity and Growth
Success can bring a business to a difficult crossroads. Sometimes to take on more business and attain greater success, a company needs significant financial investment to acquire new new capital, staff or inventory. When business managers hit this juncture, they have to wade through their financial options, which may involve infusions of equity capitals – perhaps from venture capitalists. Every situation is different, but smart managers consider the cost of success and their options for obtaining growth financing.
Ensuring Payroll Accounts are Strong
Nothing spells imminent death like a company being unable to make payroll. Even the most dedicated staff won’t stick around long once the paychecks stop. The larger an organization gets, the larger the labor costs.
Above all, companies have to ensure they have enough cash on hand to make payroll for at least two payroll cycles ahead – if not more. Financial planning to ensure your payroll accounts are in strong shape are essential to the integrity and longevity of your company.
All too often, a company’s finance department is shrouded in mystery. Many employees are unable to explain what the department is, what it does, or how it impacts the work they do.
But the truth is, finance affects each and every person. Finance communicates the overall health of an organization, explains how an individual’s actions impact the company’s success, creates guidelines for future goals and initiatives, and sets meaningful metrics to determine performance across departments.
It’s clear that taking the time to develop your financial skills can benefit you in many ways. Below are six key benefits you can realize by gaining a deeper understanding of finance, alongside three actionable tips you can use to build those skills.
BENEFITS OF UNDERSTANDING FINANCE
1. Learn How to Analyze Performance for Your Department
Financial understanding will give you the tools needed to gauge how well your department is performing, both by itself and as part of the greater company—key insights for anyone in a managerial role. It will help you determine the answers to questions like:
- Is your department performing well?
- Who should your department be compared against?
- What measures and metrics should you use to evaluate and monitor your department’s performance?
Many companies choose the wrong metrics to benchmark and monitor performance, or use the same metric for every department and, in doing so, miss the unique ways in which each department contributes to corporate profits.
A company that measures performance strictly in terms of increased revenue targets, for example, may underestimate or entirely miss the costs of increasing those targets—even as they grow higher than the increase in revenue—or undervalue key employees who provide value and impact revenue in indirect ways.
Once you understand the metrics that matter most to your department, and which appropriately measure your contributions to the company’s finances, you can establish a plan for monitoring them. Armed with this data, it becomes possible to more accurately measure your department’s contributions and identify areas for ongoing improvement.
2. Appreciate the Financial Impact of Your Job
On a more granular level, developing your financial skills will help you understand how the work you perform specifically contributes to the financial health of your company—information you may be able to leverage to negotiate a raise, promotion, or increase in other benefits.
Just as every department within a company should provide value to the bottom line, so, too, should every individual position or role. The challenging part of the equation is often in determining how this value can be monitored on an individual level.
It’s easy, for example, to understand the impact an individual member of the sales team has on revenue goals, because their performance is tied to the amount of revenue they contribute—whether or not they’re hitting their quotas. But how do you measure the value contributed by the IT or accounting departments, which perform important duties, but don’t directly interact with customers?
Every individual makes a measurable impact on the success of the company, and understanding the impact of your job, using the tools of finance, can be the best first step to reaching a higher level of performance.
3. Interact Better With Your Company’s Finance Department
Have you or someone in your department ever wanted to pursue an exciting project, only to grumble when the idea is ultimately shot down by the finance team? Have you ever wanted to propose an idea or project, but decided against doing so because you didn’t think there would be any chance of getting approval for funding?
All too often, this is the perception that individuals within an organization have about their finance department: That it’s a group primarily designed to say “no” to promising ideas.
But that perception is far from the truth. One of the primary duties of finance is to determine which projects show the most promise for a positive return on investment, and to prioritize those over projects which would contribute less effectively to the company’s strategic goals. Coming to this determination requires a lot of data and deliberation; decisions are never simply made on a whim.
Equipped with the language of finance and an understanding of the factors the finance department must consider as they evaluate potential projects, it’s possible for you to more effectively communicate and collaborate with them and generate opportunities that add value to your organization.
4. Unlock the True Sources of Value Creation
Have you ever been assigned to work on a project with questionable ROI? There’s no doubt that it’s a demoralizing experience to invest your time, energy, and resources over and over again into initiatives that, at best, have no effect on your company’s strategic goals and, at worst, have a negative impact.
To be effective in your role, it helps to understand how value is created for your business. How do your organization’s key stakeholders—members of the C-suite, investors, the general public—measure value and success?
Finance gives you the knowledge and skills to answer this question and ensure every project you take on will directly and meaningfully contribute to the success of your company. It empowers you to push back against projects that show little chance of success, or offer suggestions that might help pivot a project in a more promising direction—ultimately helping you demonstrate your unique value as a strategic thinker.
5. Know That Actions Tell Stories
Everything you or your company does tells a story that will be interpreted by someone else.
What story are you telling? Are you accidentally sending a signal to investors that hard times are coming? Or are you intentionally ensuring your actions line up with your words and paint an accurate picture of the future of your company? In a world where investors must guess about what goes on inside a company, everything is analyzed. Are you sending the right messages?
By understanding how various financial data and signals might be interpreted by different audiences, you can shape the narrative of the story in a way that would not be possible if you simply allowed the data to speak for itself.
6. Understand Investing and Capital Markets
Business aside, everyone interacts with capital markets in their daily lives, whether they realize it or not.
For example, your retirement fund is likely invested in a pension plan. Your personal investment portfolio is likely managed through a broker, or packaged into a mutual fund. And, of course, the interest rates on everything from your mortgage to your credit card are impacted by the actions of the Federal Reserve, which often takes its cues from larger economic trends.
A solid foundation in financial knowledge can help you navigate the tricky questions that are often related to these considerations. For example, it might enable you to better judge whether an investment opportunity makes sense for your financial goals—whether that be growth, safety, or a mix of both. At the same time, and equally as important, it can show you what people are looking for in terms of investments and how your actions can help to give it to them.
HOW TO IMPROVE YOUR FINANCIAL LITERACY
1. Read Finance-Focused Books, Articles, and Websites
If you’re approaching the subject of finance with little-to-no previous experience, your first step should be to establish a baseline of knowledge upon which you can build. One of the best ways of achieving this is to consume content designed and created for financial novices. There are many finance blogs, websites, books, magazines, podcasts, and videos you can turn to learn the basics.
2. Learn on the Job
It’s also possible to learn about finance—particularly how it impacts your organization and role—while on the job.
Quarterly budget meetings, if your company hosts them, can offer insight into the financial health of your organization and the metrics that are important to it.
Asking for more tasks that involve some form of financial consideration can be another great way of picking up skills. For example, developing a P&L for a project you’re working on. Even if it’s not officially a part of your role, consider trying your hand at compiling a balance sheet or conducting a cost-benefit analysis to practice the skills that you want to learn.
3. Take a Finance Course
Once you have a solid foundation of basic financial knowledge, you can further your understanding by taking an online finance course.
Taking such a course will provide you with a deeper understanding of the ways in which financial considerations impact your organization and individual role, which can help you become more effective in your job. Beyond this, it offers a real accomplishment you can add to your resume—which is helpful in the event that you look to transition to a new organization or role.
It’s important to remember: Many organizations offer professional development stipends or tuition reimbursement for employees looking to advance their skills.
TAKING THE MYSTERY OUT OF FINANCE
Finance doesn’t need to be a mystery. In fact, embracing financial understanding can be the secret to you and your organization’s success.
The key to your business lies within the accounting, finance and understanding of the numbers of your company.
Accounting and finance refer to the recording and analyzing of business activities. Understanding where your incoming and outcoming cashflow will help you make better decisions moving forward to avoid failure.
What Is the Purpose of Accounting and Finance in Business?
Accounting and finance management is so important when navigating your business.
If you don’t know where your money is going and coming from, there is a very good chance you could lose control of your business. When businesses manage their income and expenses there is a stronger potential for growth. Plus, there’s better access to strategies that can help companies survive unexpected financial downturns.
Here’s how accounting and finances impact your business management.
1) KEEP FINANCIAL RECORDS
Accounting is essentially a record of a company’s financial activities.
A company’s ledger is where accountants and small business owners can track the income and expenses of a business’ daily operations. An accurate record of a company’s finances can help a business manage their financial future and understand the cash flow.
2) AVOID LEGAL PROBLEMS
Keeping an accurate financial record helps follow important business laws. Overlooking a minor detail could have major implications on your tax management.
Financial managers need to understand what expenses to deduct, how much taxes to pay and when to pay those taxes. Poor financial recording could lead to your company being audited and could land you in unnecessary legal trouble.
Additionally, an oversight in finances improvements to your facility could mean that you’re not following the regulation of safety laws.
3) MAKE A BUDGET
Using your financial records and understanding your cash flow can help you create a budget and budget is what keeps your business on track. A budget gives you a current view of your financial standing and helps you navigate your business towards future growth and development.
When creating a budget net income, expenses, goals and anticipating unexpected adjustments must be considered. Staying on top of these numbers is essential to managing your business, so it is important to continually keep checking in on your initial plan and adjust as you go.
Good accounting sets up a blueprint for the management of your business and offers a solid foundation for stability and success.
4) ANALYZING PERFORMANCE
Successful business owners are always checking in to see how their business is doing.
A company can assess their financial position by looking at their historical and current records of liabilities and assets and other financial records. A business owner can use this information to gauge how the company is doing.
These records are an opportunity to learn from past mistakes and make more informed decisions about planning for a more lucrative future. Knowing your current financial standing can also help you identify new areas of growth that help you achieve your bottom line.
5) EXTERNAL COMMUNICATION
The communication of financial information is important when dealing with external parties.
Clear accounting and finance management can be useful when getting a loan from a bank or attracting potential investors.
Good financial management makes it easier for you to provide financial statements to external stakeholders. External users will assess these reports to decide how to proceed with their involvement with your business.
6) INTERNAL COMMUNICATION
Financial reporting can also help business owners communicate information to internal stakeholders.
This information might be relevant to employees who are interested in profit-sharing and stock-based compensation. This records also allow owners to communicate the strengths and weakness of their business with their teams.
Allowing your team to know your financial standing can tie with a bonus structure that can be used as a productivity incentive.
7) DEVELOPING STRATEGY
Good accounting and finance management inevitably leads to a good strategy. Once you’ve developed a budget and thoroughly analyzed your data, it should be easier to have a better understanding to develop a strategy to achieve your bottom line.
After reviewing your financial records, you will be more empowered to make informed financial decisions on everything from staffing to supply management. Your budget is your map to your strategy and strategy is your key to profitability.
Why Is Accounting so Important to a Business?
Accounting is an important function of a small business and often is referred to as the “Language of Business”.
The financial recording, summarizing, analyzing and recording of financial transactions help owners, managers and investors evaluate a company’s financial health. Knowing this information helps inform more strategic business decisions.
What Is the Role of Accounting in Business?
Accounting is essential to keep track of a business’ activities.
Allocating the business costs to goods or services, creating a budget for business functions and preparing financial reporting for business decisions are all aspects of accounting. Reports can be tailored to inform specific financial management strategies for individual sectors of your business.