CA(SA), consider this - 5 Financial Management Tools That Rule The Day?

Try this. . . . . 

         ACCOUNTING IS ARITHMETIC MADE DIFFICULT

I any event, the size of the numbers have grown exponentially (from shillings and pence to billions of Rands) and so the accounting systems have needed to be much more complex.

Now I am not proposing that we drop the systems and revert back to the old back-of-the-cigarette-box methods. What I am proposing is devising meaningful logical tools that can help the entrepreneur (usually not a financial man) to run the business more effectively.

The back-of-the-cigarette-box concept is more about simplicity than it is about a pencil behind the ear and a grubby dog-eared piece of cardboard.

So here are some steps to consider:

PROCESS 1: KISS THE NUMBERS (Keep It Simple Stupid)

Working in R'000 is a magical way to keep things simple and easy to grasp. (There are businesses where R100 is material but still rather show it as 0.1 than R129.)

The simpler the number format the easier it is to get a financial feel. Accuracy is a trap! To account for the business you need accuracy - to run the business you need 'feel'. 

PROCESS 2: DETAILED SALES FORECASTING (in R'000!).

What I have learnt recently is that business is all about sales and marketing. If you focus on these two aspects you will have a business. If you neglect them you will not survive.

Now I know that this sounds ridiculously simplistic but it is the truth. Yes, I know that production throughput is important and cash flow is the life blood, but the fuel of the business is sales.

Accordingly a living breathing sales forecast is the paramount business tool. It needs daily focus and continuous tweaking.

In my experience I used to get sales forecasts from the sales executives, usually in lump-sum globular amounts. Normally it was based on the previous year, with a percentage increase for good measure. In short . . . .By unhelpful.

This will not help a small business. The sales forecast needs to be absolutely detailed! It should be broken down to all its component parts:

> By salesman

> By customer

> By product line 

EVERY pertinent bit of financial information is born from the sales forecast. From material ordering to factory production to logistical requirements, even IT systems. Least of all the cash requirements! 

From a proactive management perspective, the sales forecast is the most important business tool and should be treated as such. In the beginning this document is the fuel of the business and to treat it with less priority is the recipe for disaster.

If the entrepreneur is on top of this, he has started one of the most effective business management tools.

PROCESS 3: IDENTIFYING OVERHEADS - fixed monthly expenses: 

There are two types of expenses that occur in the business:

> Fixed expenses - OVERHEADS

These are expenses that occur whether the business is opened or closed. Rent is a good example as well as salaries and leasing charges. Others include insurances, security and repairs etc.

> Variable expenses - COST OF SALES

These occur only when a sales activity occurs. If there is no sales this expense will not be incurred. Some examples are raw materials, commissions, electricity and water (if you are manufacturing), delivery charges, contract labour etc.  

It is important to identify the overheads as you can then determine how much you have to sell in order to cover these expenses.

PROCESS 4: GROSS PROFIT DETERMINATION

Gross profit is defined in this context as sales less cost of sales.

The higher this margin, the more comfortable (elastic) the business model. 

 The gross profit % is:

                  (Sales-Cost of sales)/Sales

Now here comes some magic.

If you know your GP% you can assess, on a daily basis, whether you are winning in your business simply by watching the sales figures. If your margin is as above and you know your accumulative sales figure you can see at what point your GP margin has covered your overheads.

For example:

If you have overheads of R60,000 pm and your margin is 40% then you need to do R150,000 sales to cover the overhead expenses.

If you do R200,000 in sales, the net surplus after all expenses should be R40,000!

Another useful aspect of GP% analysis is that you can quickly negotiate with customers if they get cheeky around pricing.

For example:

Assume that you have quoted R10,000 on a project and your GP% is 40% this means that you will generate R4,000 as a contribution towards your fixed expenses. If you dropped your price to R8,000 it would still be worth doing the job as it would contribute R2,000. (This assumes that you could not use your resources elsewhere to generate a higher margin).

It is important to note that the GP% needs to be checked out on a regular basis because usually there are a number of transactions going through during the month and an average will need to be established over, say, a 3 month period. This is where the accuracy and timely presentation of the monthly management accounts become critical.

PROCESS 5: CASH FLOW FORECASTING 

Although mentioned last, this is probably the most important of all the financial business tools. It is imperative to know when cash is coming in and when it has to go out.

I'm a great believer of running this tool showing daily movements (a column on the spread sheet for each day) for at least one month with an additional 5 months shown in monthly totals. 

Again run this in R'000. 

You or your accounting person should present this report daily beginning with closing bank balance from the previous day. All outflows/inflows should be projected forward for the month, day-by-day, so that the daily cash balance can projected and assessed. 

This is extremely important as it will tell you if there are enough funds to keep the business going. It will also highlight any shortfalls before they actually occur thereby allowing you the opportunity make alternative arrangements. This might include asking a supplier for an extra week of terms to getting customers to pay earlier by giving them a bigger discount. Or even getting in a new investor.

Monitoring of cash in this way will give you the edge - you will be able to see 'into the future' and be prepared.

If you, as the business owner are not on top of your cash flow you could run out of cash.

The result? 

You will grind to a halt.

And don't expect your bank to help you - they won't, especially if you are a start up.

CONCLUSION

Having these 5 simple tools at your disposal you can determine how much sales you need to do in the month to cover overheads and ensure that you have the necessary cash resources to stay alive and grow!

(Note that the balance sheet and income statement have not been discussed here as they simply record the past. The techniques shown above are predictive tools which allows for the business to survive into the future. Please also note that this is a simplistic representation - business processes can become extremely complex. The article is more about presenting effective basic principles rather than dealing with the complexities.) 

(Originally published on November 9, 2015)