What You Need to Know
What exactly is financial control?
Financial control is different from bookkeeping. Bookkeeping is about recording the figures: income and expenditure, receipts and payments, and assets and liabilities. Accurate bookkeeping, of course, is a prerequisite for effective financial control, and computerized accounting packages make accurate bookkeeping very easy.
But then, you need to use the figures as a basis for effective financial control, which means staying aware of your financial position and taking steps to resolve any problems before they become too large. Because it can be difficult to keep your business’s complete picture in your head at all times, you may want to calculate a few simple ratios or produce graphs regularly to show you the trends and help you recognize when action is needed.
What to Do
Set Objectives for Your Business
Each year, set targets and prepare a business plan that will move you toward achieving them. In addition to defining objectives in terms of product quality or marketing effectiveness, define them in financial terms. If you have investors, their primary concern will often be the rate of return on investment. If you’ve invested your own money, you may be expecting smaller returns initially and higher returns over a longer period.
Keep Accurate, Up-to-Date Books
A reliable, easy-to-use, computerized accounting system is essential for effective financial control. Make sure that you keep proper records of sales orders, invoices issued for sales, purchase orders, invoices for purchases, cash receipts, and cash expenditures. Turning this information into graphs, tables, and charts can help to reveal trends, which in turn will help you to revise your forecasts and future planning.
Carry Out Monthly Status Checks
Bring the account balance up to date and conduct a bank account reconciliation every month. The balance represents the business’s liquidity: the cash immediately available.
Prepare an operating statement showing revenue, direct costs, and overhead costs. Like a profit and loss statement, the operating statement records income and expenditure but does not show some items, such as receipts, payments, depreciation, and bad debts. Each month, compare your actual performance with your forecast for the month and, ideally, for the year to date.
Analyze the Numbers
To understand what the numbers of your accounting system or operating statement mean, you should regularly calculate:
- A ratio analysis, by calculating your costs as a percentage of the sales income. If your costs are rising as a percentage of your sales income, then you need to determine why and explore solutions.
- Your gross profit margin. If the margin is falling, it could be a sign of trouble. Ask yourself: Has waste increased? Have costs increased? Monitoring changes closely will help you to react to any problems while they are still manageable.
- A variance analysis, which is the difference between your target and your actual performance. Variance analysis looks at the differences themselves, rather than comparing different figures, as in ratio analysis. You should review figures for sales, material and labor usage, cash position/cash forecast, stock, and capital expenditure. There may be major variances, even though the overall cash position remains more or less as forecast. Make sure you understand why the figures are changing. For example, is it possible for a reduction in raw material cost to be canceled by increased wastage?
Manage Your Cash to the Best Advantage
Prepare a monthly cash flow statement so you can monitor your cash position. This statement reflects when money is received or paid out and includes items such as sales draws and taxes. Be diligent about collecting money that is owed to your business. If the level of debt rises, this could be because your sales are increasing or because your customers are taking longer to pay. Make sure you specify how quickly you expect customers to pay, and then ensure that they stick to these guidelines. Put processes in place to deal with late payments, such as interest charges or late fees.
Similarly, try not to get on the wrong side of your suppliers by taking too long to pay them, as they may withdraw your credit facilities. To gain the most benefit, you need to take the maximum amount of credit possible without abusing the agreed terms. Likewise, make your tax payment on time to avoid incurring penalties.
If you’re building up large sums of cash, do something worthwhile with them, even if you only move them to accounts that pay better interest rates. If you expect to need additional working capital, discuss your needs with your bank or your investors early, to assure them that you are responsibly planning ahead. That reassurance will make them more likely to provide additional financing. Watch your inventory levels carefully. Consider how much inventory you have tied up in raw materials, work in progress, and finished goods. If you have too much stock, you may be using excessive storage space and tying up money that could be used in other ways.
What to Avoid
You Overburden Your Business with Too Many Targets
Focus on a few key issues, such as revenue growth, profit, and cash flow, and choose a manageable number of appropriate financial targets. Compiling and analyzing huge amounts of information can be time-consuming and not always of great use if the major points are buried in too much detail.
You Allow Your Books to Get Out of Date
You need up-to-date financial records before you can control your budget properly, so record transactions accurately and promptly.
Where to Learn More
Book:
Doyle, David.
Web Site:
Entrepreneur.com: www.entrepreneur.com
