A question I am often asked is: “what is the most common mistake business owners make when they are trying to grow their business?” Well, there are a multitude of factors that will hold back business growth. Not having a clear vision, failing to set goals, inadequate planning of time, not generating enough sales or having an ineffective marketing strategy to name a few. But by far the most important factor is the lack of financial understanding that some business owners exhibit. Knowing your numbers is absolutely vital, if your business is to thrive – or even to survive!
Cash is King
Businesses go bust because they run out of money, pure and simple. Even the most badly run business will survive if it has a constant supply of cash. I have come across businesses run by people who have never taken penny out of their business for themselves. Instead, they rely on savings, investments, family or, even worse, borrowings to prop up the business and fund their personal life. The worrying thing is that they have no idea of what the financial situation of their business is! Therefore they continue to bury their heads in the sand and do the same old thing, unaware if their business is even financially viable. That’s just plain crazy!
So I’ve talked about “bad” businesses, but even good businesses that are profitable can fall foul of cash flow problems when they start to over trade. (Over trading is where the sales of a company are increasing, but the money from sales is coming in more slowly than the money is going out to pay the staff, suppliers etc.) When the money runs out, the business cannot continue, even though it has growing sales and profits.
Not all financial risk factors relate to the business itself – some are influenced by external factors or conditions that are outside our control. For example, when our customers are finding the economic climate tough, they may be unable to continue trading and could leave us with an unpaid (bad) debt. If they are a major customer, this can have a serious impact on our own business. Business owners therefore need to be vigilant for any signs that their customers may be in trouble, and keep a close eye on their debtors figures.
The Business Model
However, one significant financial risk factor that is 100% the fault of the business owner is where the business model does not actually work. Indicators of a faulty business model are:
- Overheads are too high;
- There’s not a market for the goods or services;
- The profit margin on each product or service is inadequate;
- Systems are inefficient;
- The team are under performing.
All these factors combine to produce a business that will haemorrhage cash, and that, without constant financial support, will ultimately fail.
Let’s be clear here – a business should provide you, the business owner, with the funds to support a good standard of living. Granted, it may take a few months, or even a year, to get to that position. If after that time you need to keep supporting the business financially, either by not taking any money out for yourself, or by continuing to fund it from your own pocket, you need to look again at your business model.
So how can we reduce the risk of our business failing because it runs out of cash? Well, the simple answer is that we need to know our numbers! Knowing how your business is performing financially will enable you to make informed decisions. For example, you might need to increase prices or cut costs on certain product lines. Your sales staff may need some training to improve their performance. Perhaps you might need to obtain some short-term borrowing to cover a dip in cash flow. All of these actions can help your business keep growing, but only if you do them before it’s too late!
Playing the Game of Business
In business, as in sport, if you do not know how to score, how can you play the game? Can you imagine how pointless most sports would be if you did not keep score? How would you know if you were improving, identify your weaknesses, compare yourself to the competition, or fathom out if you had actually won?
In the Book Keys to the Vault, author Keith Cunningham states that “If you do not understand your financials, you should not be in the game of business.” I am not saying that, as a business owner, you need to be a financial wizard! But you must know the basics, and be able to ask the important questions about financial factors that will impact on your business. If you have a real problem with numeracy and accounting, then employ somebody you can trust who can help you. Not understanding the rules is no excuse, when you are playing the game.
The Key Financial Reports
There are 6 key financial reports you need to understand and look at on a regular basis, that is at least monthly. (For some businesses this could be more often – weekly, or even daily.)
- Profit & Loss Account – key to monitoring your sales, costs, and profit margins for the period.
- Balance Sheet – a snap shot of the business, showing where the money invested in the business is tied up at that point in time.
- Cash Flow Forecast – a week by week projection of the flow of cash in and out of the business.
- Aged Debtors & Creditors – how much you are owed and owe other people, and for how many days the amounts have been outstanding.
- Budget – prepared once a year and reviewed monthly, to ensure that costs are kept in check and sales are meeting targets.
- Key Performance Indicators – KPI’s that are specific to your business are the pulse that tells you how fit your business is. They can cover any aspect of the business from the number of leads coming in, the rate of conversion into customers, right through to wastage and down time.
When you start learning about your financials it can be difficult and confusing, but it is no different to learning a new language. You can put in the effort, read books, take a course etc. Or you can dive right in, speak to people who talk the language, use what you learn daily and pick it up that way.
There should be no embarrassment in asking for help to understand your financials. Unless you have trained as an accountant, how would you know how to produce and interpret these statements? It’s just another skill you need to develop as a business owner, and asking for help from an expert is the smart thing to do! The only embarrassment is if your business fails because you misread your score, or didn’t keep score at all.
So don’t wait until your number is up – take ACTION now, learn the rules of the game and become a financial master! And if you need help, why not come along to our Finance Mastery Workshop? Ask us for details!