Leaving the glitz and glamour of sales and marketing, it’s now time to have a think about you handle the money side of your business. Despite being fairly dry and not particularly exciting, this is the most crucial aspect of your business. The majority of business ventures fail because of poor cash flow management, so if you aim to be in business for more than a few months, this is something you absolutely must get right.
There are two main parties interested in your accounts: you and your investors. Professional investors will generally use a number of standardised ratios to compare your business to their other investments. The most important ratio they use is the current ratio, which shows how many times your assets could cover your liabilities:
There isn’t an ideal ratio; different investors will want to see different things, and the optimal balance also depends on your particular business and the industry sector it operates in. However, the riskier your business, the bigger the current assets side of the ratio should be.
Credit control involves managing both money owed to your business and the money it owes to others. Ideally, you will have cash sales and longer payerment terms with your suppliers. Sadly, many small businesses starting up find that they can’t get credit payment terms with their suppliers until they have a track record of six months to a year. In addition, if you are selling business to business, you may find that you have to offer your customers payment terms, as your competitors are already doing so. This could make cash management difficult when you are first starting your business, and the only way to make sure you don’t end up in penury after just a few months of operation is to make sure that your business plan reflects the payments you will have to make, and the delay in any payments you are due to receive.
It’s important to have a clear idea of what you owe (and are owed) and when it will be paid. If what you are owed is more than what you have to pay, you shouldn’t run into difficulties. You can keep an eye on this moving money through the use of debt and credit schedules, which will layout how “old” a payment is and how much for. If you start having any problems with your credit control, you can look to these schedules to see how your can improve your cash flow, either by amending payment term, calling in payments early or sending out advance invoices.
How much you focus on stock control will depend on the type of business you run; it is obviously far more important in a manufacturing or retail setting than for consultants or other service professionals. Nevertheless, this is another area where loose controls could lead to lost money, so it is important to get it right. You should make the best use of your working capital by keeping stock as low as you possibly can while still being able to run your business.
Various factors will affect the level of stock you keep, such as transport costs, scarcity, seasonality or even the cost of buying in bulk rather than smaller units. Only you know what is best for your business, but you want to make sure that you do not tie up a substantial chunk of money in stock that you are not able to immediately sell. If it is in raw materials or in a state in which it can’t be sold, it is actually losing you money, as you could have put the cash in the bank to earn interest instead.
Keeping your money working is another important factor when managing your business finances. In addition to credit control and stock control, you also want to know that your money is working for you, in terms of the interest rate you earn, and the terms under which you are borrowing funds. Channel any surplus funds in to a business savings account, as it will earn a higher interest rate there than in your business current account. Also, even if you do have your funding lined up, don’t dismiss the notion of asking your bank for a better interest rate on your lending if you are materially worse off than you would be with a different lender. While they don’t have to say yes, or match the terms on offer elsewhere, it is worth investigating, as if you won’t get a better rate if you don’t ask.
If you can manage the money in your business effectively, you are more likely to succeed over the long term. The next post in this series will involve further detail on financial management and controls.
[Image by KM & G-Morris]