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Financial management

A new business means great opportunities for everyone: employees enjoy greater growth rates and promotions, customers get more competitively priced products and services, business owners gain increased profit potential, and the market opens up to more job opportunities and economic growth.

However, managing a new business is no easy task – handling your finances and having a record of cash flow is essential to staying on top of the game. It’s therefore essential to prepare an accurate and realistic financial management plan which incorporates the unique needs of your company with the current and future market trends.

Here is an overview of how to effectively plan your finances so that your business is on track from day one.

— Starting up

You have two choices when starting up your business:

Just as a financial year sees many ups and downs, a business goes through various stages during its life cycle. During the initial start-up phase, you may want to invest more into buying raw materials or other resources. During the growth and expansion phase, when you’re opening up a new franchise or expanding into a new market arena, you may want to invest more in marketing and promotional initiatives to spread the word and increase your customer base.
What’s most important to remember during any of these stages is the golden rule of business: always maintain a balance between your assets and liabilities on the balance sheet. In other words, at all times ensure you are worth more than you owe. Always balance your equity and debt – the equity position on a balance sheet, which is equity divided by assets, should always remain between 30 and 50 percent.

— Managing your money

While increased return on investment and profits are necessary for growth, it’s your accountant’s job to show as few profits on paper as possible to allow you to save on taxes. It’s a good idea to discuss with your accountant how you can legitimately transfer forward some of your operating expenses in order to increase your current profits.

But growth is not just about money – you also have to make major investments in terms of time and effort. You will be required to put in extra personal time, which might take a toll on your social life. An increased workload also means you might need to hire additional manpower. Before you initiate the growth phase for you business, carefully consider all the risks and benefits, and determine whether you have the necessary time, money and resources.

Remember: there is no right or wrong way, but it’s best to seek advice from experts who have industry experience and can guide you through the challenging growth phase. Accountants, lawyers, small business associations and even government publications provide useful information about making the right decisions.

— Understanding financial statements

Balance sheets and income statements are checks that tell you about the health of your business and are used to keep track of your finances. They are used to manage your operations and provide information that you and your accountant may need to make important financial decisions and formulate effective business strategies.

A balance sheet tells you about the net worth of your business at any given point in time. It includes information on your assets or your worth in declining order of liquidity (the commitment, liabilities or money you owe others) and the owner’s equity (the amount of money that actually belongs to the owner of the company). Capital assets, such as the value of buildings or property and equipment are also included.

An income statement can also be referred to as a profit and loss statement or simply a P&L sheet. It reports on the income made versus the expenses incurred over a specific period of time. The problem with drafting this sheet is in attributing certain costs to specific periods of time and incorporating the depreciating value of various fixed assets, such as equipment and other property.

The balance sheet and income statement are bound together by a formula: the equity at the beginning of the balance sheet added to the profit or loss incurred from the income statement equals the equity for that period.

— Projecting financial statements

Before initiating a growth phase, it is important to develop a projected income statement, cash flow statement and balance sheet. These documents can be developed one, two or even five years into the future, depending on your situation. However, estimating figures that far in advance can be tricky. Profit margins are particularly difficult to accurately predict. If you go too high with your profit margins, your investors will consider your project unfeasible and not realistic. If you go too low, they won’t be interested in investing in your business.

The aim is to be reasonable and realistic and make sure you’re in line with the profit margin standards within your industry. Exceptional return rates such as 100 or 1000 percent are usually more achievable in smaller businesses with smaller initial investment levels.

It’s also a good idea to make several projections in order to incorporate potential future market trends or liabilities. For example, if you currently have a business with sales of $300,000 a year and you want the business to grow to $1 million by the 3rd year, you can make either of the following projections:

Projection A:
Year 1: $500,000
Year 2: $750,000
Year 3: $1 million

Projection B:
Year 1: $600,000
Year 2: $800,000
Year 3: $1 million

Projection B shows high initial, fixed investment with a slower growth rate, while projection A shows smaller initial investment and a gradual growth rate supported by subsequent reinvestment profits from that year. Computer spreadsheets can help you prepare projections quite easily, or you can seek the help of a financial expert.

— The break-even point

The break-even point can help you visualise the relationship between various costs over time. It identifies the moment where you have recovered your total cost and begin making a profit, and is often displayed as a dollar amount on a graph.

There are two types of costs: fixed and variable. Fixed costs are those that do not change with time or sales and profits, such as the cost of purchasing standard machinery. Variable costs change over time and depend on sales volumes, such as purchasing materials and labour costs.
The following example explains how to calculate your break-even point, using a hypothetical income statement that looks like this:

Sales: $200,000
Cost of sold items: $60,000
Wages: $40,000
Fixed expenses: $80,000
Profit: $20,000

First, we’ll calculate the contribution margin, which is the percentage of sales available for use toward fixed cost and profit. In the above example, the variable costs are 50 per cent of sales so the contribution margin is 50 percent. The BE point is the fixed costs ($80,000) divided by the % of sales the variable costs represent (50%) which equals $160,000. Here, all fixed and variable costs are covered. To verify, multiply 50 percent by $160,000. The amount is the value of fixed costs or $80,000. The variable cost at this rate is $80,000 or 50% of $160,000.

— Overheads and costs

Budgeting for your business is tricky business indeed. If you estimate that you’ll need more than you actually do, you may end up borrowing too much money from creditors and have to deal with excessive interest rates. On the other hand, if you underestimate the amount of finances you’ll require, you may end up not being able to carry out the operations you need to make your business grow more profitable.

Here’s a list of some of the operational and overhead expenses you should keep in mind when growing your business:

Building costs – Determine a blueprint for the building and get bids from various contractors to help you get the most competitive prices. Make sure you set realistic and accurate deadlines taking into consideration various external factors which may affect the construction work.
Equipment costs – Talk to different suppliers to make sure you get the right equipment at the best price. Bear in mind that there are always additional expenses such as installation and delivery.
Inventory costs – This is your initial product and its cost determines how efficient your output is. It’s a good idea to base this on past inventory sales.
Accounts receivable – Projections made on accounts receivable are usually based on existing receivables on the balance sheet.
Additional expenses – There are always additional expenses that don’t fit into specific categories – however, they should not be left out of your predictions.

— Balancing sales and expenses

When preparing your cash flow statement, you need to ensure that your sales and expenses are carefully balanced. It is often a good idea to create a daily or weekly cash flow projection. You may also consider changing around the month’s beginning and end dates so that the cash coming in during a particular time period is enough to compensate the cash that needs to go out during that period.

There are various kinds of spreadsheet software that can help you undertake detailed cash flow analyses. It may seem obvious that when you increase sales, your cash flow increases – but that’s not always the case. If you’re offering credit, sales may be based on credit transactions, which means that the result of increased sales will be increased accounts receivable and not incoming cash flow. And while sales expenses are incurred before the actual cash comes in, receivables are collected on an average 30 days after the transaction has occurred. The cost of depleted inventory which has gone into making those additional sales needs to be compensated; therefore your cash reserves may actually reduce.
Make sure all the financial data is accurately tabulated and all necessary calculations are done bearing in mind any unforeseeable circumstances that may arise. Make sure that you also keep in mind the tax obligations you have and compensate for them adequately in your statements and projections. You can use the excess cash volumes to make sure that you meet your income and payroll tax obligations.

It can sometimes be necessary to take out a short- or long-term loan in order to balance your cash flow. Short-term loans include equities or revolving credit lines, and come at a risk: if your business experiences inadequacies, the bank may cancel the credit line at any time. Long-term loans require you to pay back the loan amount in the form of monthly instalments which include the principal amount and interest. If you’ve taken out a long-term loan and you’re experiencing a peak or boom in sales, it’s probably a good idea to invest in short-term, interest-bearing low-risk schemes.

— Managing expenditure

The best way to earn a buck is to save a buck. There are various smart business practices you can use in order to make sure that you’re keeping overhead and operational costs to a minimum, thereby increasing your profitability.

Below are some techniques to help you become penny-wise:

— Keeping track of paperwork

Particularly during this crucial phase of your business development, it is extremely important to make sure you have set up a proper financial management or accounting system to keep track of where your money is. You need to be aware of every cent or you risk spending money that you don’t have. In a growing business, financial needs are very dynamic, so you need to make sure your financial accounting system is flexible enough to adjust for constant changes.

There are various different accounting systems available, and it is important to carefully compare each to ensure you choose the one that best serves your interests and needs. Computerised accounting systems and software such as MYOB and QuickBooks are great user-friendly applications that can help you get more organized.

Whatever the system you may choose, always remember that it’s important to have an idea of where your money is and how it is being spent. In order to make profitable business decisions and grow your company, you need to have detailed and accurate information ready at your fingertips.

It is a good idea to enlist the services of a professional accountant to help you not only with documenting and maintaining records, but also for getting useful advice and suggestions on taxation and business planning.

— Managing cash flow

Once you have collected the funds necessary to grow your business, you need to make sure that you manage them wisely. It’s important to keep regular checks on your cash flow by undertaking cash flow projections. These may be done on a monthly or yearly basis (or as per the specific needs of your company).

When projecting your cash flow, you need to make sure that you have adequate cash in hand every month to repay any loan instalments for the next month. If you have too little, you may want to rethink your business plan or profit-generation strategies to generate more cash; if there’s too much then you need to think about whether your loan amount is too high or whether some of the excess cash should be re-invested for further growth.

You can optimise your cash flow management ability by ensuring loans are secure, collecting accounts receivables in a timely manner, making your credit requirements easier, focusing on increasing your sales figures and devising optimum product pricing structures.

Undertaking a detailed analysis into your financial projections can help you plan your budget more effectively, allowing you to review and revise your business plan and ensure you are meeting all goals and objectives. It is always a good idea to call in the help of a financial expert – many accounting firms offer professional cash flow management services which can save you a lot of time, money and future problems.

Nicoll Jackson give you peace of mind by looking after your financial and accounting operations.

We also use our business advisory expertise to monitor your business, giving you
proactive advice on how you can improve your bottom line and net worth.

Contact us today