Finances is an integral part of any business. Let us be honest there is no sense in running a business that is not profitable unless it is for a charity cause. The sad reality is that plenty of business owners don’t spend a lot of time on managing and analysing their finances. Finances is often perceived to be boring, complicated or only a support function within a business. The truth is the better you manage your finances, the more successful your business will become. The better you know your numbers, the more powerful decisions you can make.
You can outsource your finance function or appoint financial people in your business, but as a business owner you should still know and understand your numbers. There are plenty of important numbers in your business you should know. The numbers will also differ from business to business – what might be critical for one business, might not be important for another type of business. Let us discuss the six numbers that are important for the majority of businesses:
Cash flow is properly the most important number in any business. Multiple large corporations have closed their doors due to cash flow problems. A business can be profitable with good sales, but experiencing cash flow problems. Cash refers to the physical cash that you have available in your bank or investment account. Cash is needed to pay the expenses, pay creditors and to grow your business.
Cash management goes hand in hand with how well you are managing your debtors and creditors. You could have had great sales, but many of the customers / clients have not paid yet. Or you need to pay your suppliers and expenses before you will receive the cash. Both these scenarios can create serious cash flow problems.
- Sales (Revenue / Turnover)
Your sales determine your revenue or turnover, in other words the revenue / turnover before cost of sales or expenses have been deducted. In theory, the more you sell of your product or service, the more profit you will make (although this is not always true). Therefore it is important for any business, to know and manage their sales numbers. It certainly helps to pro-actively identify a decrease in sales and investigate the reasons for it.
It is also important to identify trends. For example, an ice-cream company might see a decrease in sales during the winter months but a spike in sales during the summer months. By knowing these trends you will know whether a decrease in sales is due to the nature of the business or whether there is a problem. You constantly want to drive your sales numbers and exceed the set sales targets.
Profit is determined by deducting cost of sales, expenses, and tax from your revenue / turnover. You want to end up in a profit position and not a loss position where your cost of sales, expenses and tax exceed your revenue / turnover. It is possible to reach sales targets but make a loss. That is why costing and pricing of your product / service are critical aspects of your business and so is expense management within your business.
Profit can be increased by either increasing your revenue or decreasing your expenses. You will pay tax on profit, therefore you need to also take tax into account when you do your budgets and forecasts.
- Direct and indirect costs (expenses)
Profits are directly impacted by expenses. It is important to know both your direct costs and indirect costs since both costs play a critical role in the pricing of your product or service. A particular product / service can perceived to be profitable, but once you also take the indirect costs into account, the product might be selling at a loss.
For example: if you sell hotdogs, your direct costs will be the cost of your bread rolls, the sausages, the sauces, the butter and the packaging. Direct costs are the costs attributed to delivering your product or service. The indirect costs might include things like the electricity to heat up the sausages, the salaries of the staff members preparing and selling the hotdogs and marketing costs. Ensure that you take both direct and indirect costs into account when you set a price for your product / service or determine your profit margin.
- Budgeted numbers
A budget is crucial for any business regardless the size of your business. A budget is an effective tool to help you plan for the year ahead. You also want to do forecasts for the medium and longer term i.e. 2-5 years and 5-10 years. Forecasts help you to identify those big future expenses that you ideally want to start planning for early on i.e. moving into a bigger office, replacing your computers or buying a delivery vehicle.
It is however inadequate having a budget if you don’t compare your actual revenue and expenses to your budgeted numbers. By comparing your actual numbers against your budget and analysing the reasons for variances, provides you with valuable information to make effective financial decisions.
- Debtors (Accounts receivable)
Ideally you want to run your business on a cash basis. It is however not always possible and the nature of many businesses force you to allow for debtors (also referred to as accounts receivable). Long outstanding debtors can create cash flow problems and irrecoverable debtors can cause for your business to close down.
Know your debtors and constantly manage your debtors’ balances. Adopt a payment policy and communicate it to your customers / clients. Do credit checks on your customers / clients and stop providing products / services to them if they don’t pay you within your set timelines.
Start off by knowing and managing these six numbers. It will certainly help you to create a more profitable and successful business.
This article was written for publication in the Woman Entrepreneur magazine.
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Written by: Ronel Jooste