An organization’s financial management plays a critical role in its bottom-line success. For small businesses, entrepreneurs, and startups especially, revenue and expense fluctuations are typical and can add to the burden of managing finances successfully. It’s hard to find great advice on managing your finances; the world is full of articles, videos, books, advisers, and consultants, each with their own biases and opinions on what to do. In this article, we will instead focus on a couple of the basic principles of financial management and the tried-and-true strategies for navigating them effectively.
Financial management is all about moving, controlling, and evaluating cash flows across a business’s operational cycle: producing a product or service, making a sale to a customer, collecting the money and starting the process all over again.
Managing finances centers around multiple aspects: purchasing raw materials, turnover ratios of raw materials and finished goods inventories, collection of accounts receivable from customers, paying bills, suppliers, and employees and establishing appropriate credit facilities to buffer business fluctuations.
When making management decisions, business owners and managers must consider how fluctuations in these internal/external operational facets will impact their profit margins, cash flow, and overall financial performance.
Ultimately, learning proper financial management strategies is vital for a business’s success.
Bookkeeping and Accounting
John Nessel, President of the Restaurant Resource Group, says, “If you can’t count your money, you can’t manage it.” Businesses cannot operate without money; Nessel argues that those who can’t control their cash flows and profits ultimately cannot control their business. While the complexity of a bookkeeping system and the number of transactions can vary between small and large businesses, the function of this process is consistent. Businesses have to record daily transactions, produce invoices, process payroll, and maintain/balance subsidiary ledgers, general ledgers, and historical accounts. Continuously, accurate bookkeeping helps businesses keep track of their profits and losses and generates information to project future outcomes.
Accounting, on the other hand, is distinguished from bookkeeping as a higher-level, subjective system that measures, identifies, records, and communicates compiled financial information. Comprised of preparing adjusting entries and company financial statements, analyzing costs of operations, completing income tax returns, and aiding the business owner in understanding the impact of financing decisions. A strong accounting process helps build a big-picture understanding of profitability and cash flow awareness. The intertwining functions of accounting and bookkeeping processes are vital to a business’s long and short-term financial sustainability.
Accounts Payable (AP) and Accounts Receivable (AR)
“It takes money to make money.” Regardless of the size/type of your business, you are most likely paying someone for something to keep your business running. Altogether, these unpaid costs to outside vendors for goods and services, comprise its accounts payable. Accounts receivable, contrarily, are assets; the money that a business has a right to collect for selling products or services on credit to a customer.
How do the terms apply to financial management? AP/purchasing records provide an organization with information about accounts with suppliers, be it outstanding invoices, costs-of-purchases, or details on how the organization made payments/purchases. This information can be used to evaluate vendors, seek better pricing, cost out products or project future cash outflows. AR systems, on the other hand, can help a business produce payment reminder letters and recover past due accounts before they become bad debt as well as help forecast future cash inflows.
As a business matures, frequently more cash is necessary to finance its growth. We’ve discussed the role of strong financial management in tracking and managing cash flows, making future projections, and budgeting for business needs. However, the financial management system is also instrumental in helping to identify and evaluate investment opportunities that can complement or enhance the organization’s current condition. Ultimately, by carefully considering information from its financial management system along with market conditions and needs while exercising sound business judgments, a business can confidently determine if they’ll reap the benefits of investing in a new project.
Understand Risk & Educate Yourself
Another primary objective of the financial management system is to provide information to help management develop strategies to mitigate risk. There are two main types of risk: business risk and market risk. Business risk is the potential that an individual company will do poorly or fail. Business risk can be managed through diversification, the strategic process of allocating capital to reduce a business’s exposure to any one particular asset, market, customer or risk. Good financial management can help minimize business risk by identifying cost problems, customer issues, unprofitable products, liquidity issues and the like.
Unfortunately, market risk is inherent to the market as a whole. However, even though one cannot control the market, there are actions that can be taken to mitigate market risk. With proper financial management and analysis, market trends can be identified and corrective actions can be taken. This might involve reducing costs, changing market segment strategies or enhancing a company’s credit facilities.
The bottom line is that there are always risks involved in business. However, with proper financial and business management, risks can be managed.
Need help? Ask Those With Experience
For many, the most challenging step in financial management is knowing where to start. For others, it’s merely maintaining the course. Small business owners’ financial decisions will impact the entire company and the people that are part of it; so it’s important to have the proper financial management systems in place to provide information to inform management when making key strategic and operating decisions. Lauber Business Partners can help guide you through every step of the process and ensure that the financial decisions you’re making are best for both your business’s present and its future.