Why financial management is more important to a business.?
Well, Business Finance is a broader topic where we discuss how to plan, organize, direct and control the financial activities of a business; in simple terms. For this we need to understand the elements of financial management and the relationship between each element which will be discussed in detail throughout this guide.
Well. businesses have their owners and managers both are equally responsible for managing business finance. Well business does need profits in long term otherwise no one would come and start a business Its basically depends on the decisions and actions they take.so be careful, and don’t worry we are here to help.
Business Finance Life Cycle
First, we need to identify the life of a business because the decisions you make should be in line with where your business stays in the business life cycle.
As humans, we have a life cycle so do businesses have their own life cycle
As we can see in the Introduction stage Company will be trying to identify there customers, therefore we cant expect a high sales in this stage even though your products are at the market place. Customers are less aware of the product. So we need to be careful with the money because even though there will be less sales we have to run our business, pay our suppliers and employees. That’s why the costs are high during the introduction stage.
So what to do?
Golden Rule Prepare in Advance.
Before we start things, owners and Managers have to make a forecast and see how much cash are we going to have as cash reserves during this period. Therefore budgeting is very much important during this period. Owners have to predict the cash outflows and see whether there’s a surplus or deficit at the end of each period and have some idea how much capital will be needed to fund the requirements of the business in coming months. This period business has to cut down unnecessary costs and reduce the Cash Outflows for unnecessary items such as entertainment costs. So once we tackle this stage the business is now established and start to rise.
How a cash budget looks like?
In Growth Stage now little business may need more space, more employees, latest machinery therefore its time to spend on Capital Expenditure. As a business grows it needs more money to fund its growth sometimes during this period all retained profits are re-invested in the business without high withdrawals by the owners. Therefore now business has to decide what are the sources of finance available to them.
Deciding whether to fund internally (Owners capital) or borrow from outside (Long term debt) this decision must be made by financial managers. They must select the best source at the lowest cost which gives a higher return to owners. This cost has a special place in financial management it is called Cost of Capital. Higher cost of capital will result to reduce profitability and increase the risk to owners such as debt is stacked within the business causing high leverage which will adversely affect the business.
As the business enters maturity stage now they have enough facilities to run business and enough assets with them at this stage the costs will be somewhat lower due to operational synergies, economies of scale and learning curve effects (employees are now more efficient) therefore the profits will be high. So how shall owners and managers would act? Will they take all the money that business generates. As the profits increases they have to find good investment opportunities to invest this additional profits, such as buying shares, invest in new projects, expand market share..etc.Business is now focusing on shareholders wealth maximization or known as owners wealth maximization. However at this stage business should be vigilant that it should keep sufficient money to run business (Known as
Liquidity) while increasing the profitability by investment; which is known as working capital management.
How to manage business finance with working capital.
Working Capital cycle
Well we are now aware of cycle of the business and next step is to identify cash cycle (Also known as cash operating cycle).
Assume Geeky Company buys raw materials from suppliers that allow geeky 2.5 months credit period to pay. Prior to selling raw materials remain in inventory for 1 month and it takes 2 months for geeky to produce goods the goods are sold within a couple of days of production being completed and customers take average 1.5 months to pay.
From below analysis you can decide for how much time you need to manage your cash in the business
Time that stocks remain in the inventory 1.0
Time taken to produce goods 2.0
(Less)- Time taken to pay suppliers (2.5)
The time taken by customers to pay 1.5
This is called the cash cycle how your cash goes out and comes in, better financial management to grow up your small business is that effectively moving your cash during this period. Also, these 2 months from above scenario is called “Cash Dry Period” because you have to find a way to pay your suppliers on time otherwise, they will be unhappy and won’t let you purchase further on credit. On the other hand, you should give your customers their maximum credit period. Otherwise they will be dissatisfied so you must manage it properly.
Few strategies you could use.
Obtaining an overdraft
Offer early settlement discounts for customers
Obtain credit extensions from suppliers
Sell some investments you have
All above has a cost so make sure you see the benefits are increasing the costs. So use these tools effectively to your situation.
The world is going through a economic downturn these days due to Covid-19 pandemic therefore your business should more liquid funds to run there businesses and effectively manage. Otherwise businesses would collapse if they cant pay suppliers and will cause higher financial distress costs and eventually businesses will reach bankruptcy.
7 Tips for Managing Small Business Finances
Lets summaries what we have gone through so far.
1. Prepare in Advance- Always work with a budget.
Your first task is planning. If you plan no one could stop your progress. You can start from the beginning you may not have prior numbers. But you can plan your future income and spending, remember you may not be spot on with your numbers but you can make a variance analysis at the end of each period by comparing budgeted and actual. Then you can see from where we have spent more and what is the reason. Were there any inefficiencies? if so what we can do? Were there any expenses that shouldn’t have incurred. Likewise you can analyses your performance through a budget.
A proper budget will make you more aware of the business. Continue this for some period then you can make budget in more accurate way which you can manage your money more efficiently.
2.Know your Deadlines.
This point is linked to above point you have to be aware of the expenditure that fall due future. These could be loan repayments, bills, payables. etc knowing your due dates will help to plan your expenses.
This would avoid additional interest, penalties added to your payment if you don’t make payments on time.
3.Record your transactions and Review them
Keeping your accounting records is very important if you want to manage your finance. You can use the concept of double entry accounting to record your transactions and prepare accounts and review them regularly basic elements of financial statements that you require is,
Statement of Profit or Loss– Measure your performance for the period
Balance Sheet -Measures the financial position as of a particular date.
Cash Flow Statement– reflect movement of cash transactions and impact to the cash reserves
Sometimes this could be difficult to handle alone because there are lot of cash receipts and payments going in and out per day. However there’s a solution
To do this there are lot of accounting packages which will help you to do this task. Few of most used accounting packages are QuickBooks, Sage, Accpac,Peachtree..etc.
4.Keep your business separate
Its true that you are the owner of the business. However you must keep your personal accounts and business accounts separately. Don’t go and record your transactions in business, limit your drawings as much as possible, otherwise your accounts will be more disorganized and may lead to overspending what you’ve earned. Increasing your businesses reverse will improve its future growth. So If you want to get succeed never mix up your personal expenses with business. What you have to do is put your own money in business and save them for future use.
5.Dont leave your cash in the drawer
Above we have discussed how business could grow when you have extra cash in the business don’t keep them behind because with the time value of the money will increase (Time Value of Money). Therefore you should also go and invest in suitable investment opportunities to earn extra income.
But you have to plan this in a proper way remember we discussed about a cash dry period in your business. So don’t overspend on investment, invest only extra funds. There are many ways you can spend
Investing in Short term REPO market
Investing in Stock Exchange
Investing in Money Market
Investing in Call/ Fixed Deposits
All these are ways that you can further investigate and you have to decide your own method of investment. .
6. Reduce your costs and increase revenue
This is called operational efficiency of the business,
Actually if you carefully see and analyses your spending through budgets and variance analysis
For example you can see whether marketing cost is spent on what? Is that spent on a foreign tour searching for vendors? Or spent on promotional activity to increase revenue?
Apparently searching for vendors may not have given you a good benefit so that could’ve been avoided and expenses that cause more benefits you can allow. Just because it’s an expense there’s no rule that you must spend it. See the benefits beforehand and then spend it.
7. Have your own Goals
Finally the confidence is more important than your financial strategies first there should be proper goals for you to work on them then only you can apply all the above discussed matters so when setting your goals using SMART GOALS is recommended.
What are smart goals?
We have to set our goals based on the 4 SMART criteria mentioned. Specially when its come to a business you can have both financial and non-financial goals and as business owner you can quickly eliminate non value adding activities in your business and then trim your costs to increase profit margins.
Managing finance in an organization could be performed by several people through several manners, however it is important that they manage the finance to support the organizational objectives.
Functions of Financial Management
- FINANCE FUNCTION
To manage finance we should have finance, so an organization could obtain finance through
EQUITY- issue of new shares
DEBT- Issue of Debentures/ Bonds
Obtaining finance will incur a cost to the organization
- INVESTMENT FUNCTION
The obtained finance is now invested, Basically there are two types of investment decisions that an organization should take.
1.Short term investments- run day to day business
2.Long term investments – Investment in projects, business acquisitions. etc.
Investment will result a profit to the organization
If the organization had succeeded in making a profit above the cost of obtaining funds business had managed the finance to support the organizational objectives vice versa. NICE..!!!
- DIVIDEND FUNCTION
After paying interest to debt holders what the business can do to their retained profits?
Of Course, pay them as dividends.
Dividends plays a vital role when it’s come to Listed Companies since it gives signals to the market regarding the company’s performances.
Therefore, an organization must carefully decide the proportion of profits that needs to be distributed as Dividend Paid & proportion of profits that need to be retained for future investments.