Small Business Finance Management
By Ray Harrison, Fractional CFO at The Finance People
Sound financial management is at the heart of every business, no matter how big or small. It is essential that a small business owner does not ignore this because even viable and potentially profitable businesses will fail if it does not consider, review and implement its financial strategy.
But, where to start. Important financial decisions have to be made right from the off. Small Business owners need to engage the resources to turn to that will guide them through the critical early decisions and financial tasks that need to be undertaken.
Managing the finances of your small business should not be an afterthought.
There are 5 key areas which must be addressed to give you the best chance for your business to succeed.
1. Cashflow
2. Accounting basics
3. Financial Planning
4. Understanding Business Finance Options
5. Managing Business Debt
1. Business Cashflow
Payment terms
Some businesses are able to take customer payments for their goods and service immediately, but others will need to offer credit of between 30 and 90 days. Extending credit to customers can be an effective way to attract new business and build trust, but it will also have a direct impact on your cashflow. You will have to consider how you operate your business while waiting for customers to pay.
Also, there is the problem of late payments and how you deal with these, either by offering discounts for early payment or charging interest on late payments. In addition you should take into account the credit worthiness of your customers – using credit agencies where possible and ensure your customer is fully aware of and agrees to your payment terms. To reduce the likelihood of payment delays, get to know your customers and put systems in place to “credit control” any issues.
Forecast of Sale Income
With the above in mind it is essential to create a business plan and forecast of Sale Income, Costs and how these will affect your cashflow. Cashflow is critically important and the lack of cash generation is one of the most common reasons why businesses fail. Put simply, if your customers don’t pay and you are unable to pay your suppliers and employees you clearly will have a problem.
Cashflow statement & forecast
In order to manage the business effectively, a Cashflow Statement and Forecast will provide the necessary expected financial outcomes of your decisions and give a clear road map of your funds in and out.
Accounting Basics
Unfortunately, it is a fact that businesses need to keep track of the various financial transactions of sales, purchase expenses etc, and whilst this may seem counter-productive these tasks are critical, not only to remain compliant in the eyes of HMRC, but also to generate valuable information for running the business effectively.
The reality in current times is that the majority of small businesses use cloud accounting software to make day-to-day accounting tasks relatively easy. You should also engage the services of an accountant to take care of your reporting and filing obligations. It is a sobering thought that many businesses fail because of poor bookkeeping.
The practicality of business accounting is covered by:
Opening a business Bank Account (this is a legal requirement for limited companies).
Choose and install cloud accounting software in conjunction with a small business accountant and consider hiring a qualified accountant to submit tax returns (including VAT) and file company accounts. They will also help to keep the financial side of your business in check, as well as eliminating accounting errors, avoiding late filing penalties and taking these pressures away to enable you to concentrate on growing the business.
Financial Planning
Financial reports have a crucial part to play in any small business. They have many uses, from the internal tracking of revenue and expenses to proving the viability of the business to investors and finance providers. (Banks and other lenders).Keeping on top of your financial planning will help you to identify potential issues before they arise and allow you to make more informed decisions.
There are four main financial planning documents to be produced and regularly reviewed:
Profit and Loss Statement
This summarises the business revenues and expenses over a period (Monthly and Annually). An accurate Profit and Loss Statement will allow you to measure the business profitability over time, and critically determine your break-even point (the revenue you must earn to cover the company’s total costs).
Creating profit and loss projections for future years will be invaluable in mapping out the business’s future. For example - It will show if you are creating sufficient profits to finance the purchase of assets, increase staff or even reduce costs.
Balance Sheet
The Balance Sheet gives you a snapshot of the business’s financial standing at a given date. It consists of 5 parts:
Fixed Assets – Buildings, Machinery, Vehicle
Current Assets – Stock Debtors, Bank balance
Current Liabilities – Creditors, any other amounts owed to third parties
Long Term Liabilities – Mortgage or Long Term Bank Loans etc
Equity – The amount the owners have invested in the business by way of Share Capital, Loans and Profits made.
The net value of these pieces of financial information are used to calculate the net worth of the business at a specific time. A positive Balance Sheet ( Assets exceed Liabilities shows that the business is built on solid financial foundations.
This is particularly critical for third parties such as banks and prospective investors as it gives a clear picture of how the business is financed.
Cashflow Statement
The level of cash in a business can make or break its financial health and for that reason is a document you are wise to create and maintain.
A cashflow statement reflects the inflow of revenue and outflow of expenses from the business activities over a specified period, (Typically a month, Quarter or Year). It enables you to make sure there is enough cash in the business to operate effectively on a day-to-day basis and take action if problems are highlighted.
Breakeven Analysis
This document is used to determine your level of activity (Number of Units you must sell or amounts of revenue you must receive) in order to cover your costs. It will assist in determining your optimal sales price, ensuring that costs are minimised and so evaluate any potential business expansion.
Business Finance Options
At some point in the development of a business, there may be a need to seek some form of business finance. This may be short term to cover a specific project or cashflow issues or to fund the business growth over the longer term.
There are many options to explore to raise money for the business, but securing these funds can be tricky. All options should be considered carefully. The 2 main types are Equity and Debt Financing.
Equity Financing
Equity Financing involves securing a third-party investor to provide funds but they will want a say in how the business is run and a share of any profits made.
Pros and Cons of Equity Financing
Pros
Reduced Risk
Improved cash flow
Long Term Planning
Bypassing credit problems
Cons
Cost – High level of risk
Loss of Control
Potential for conflict
Debt Financing
Debt Financing is more usual whereby a lender (Bank/Finance Company) will allow the company to borrow money, on which they will charge interest, and the borrower agrees to repay the loan and interest at the end of the agreed period. The lender does not receive a share of the business.
Pros and Cons of Debt Financing
Pros
No dilution of control
Interest charges are tax deductible
Repayments and costs are predictable
Cons
Repayments are fixed, so no flexibility
Lenders will ask for security – Owners Personal Guarantee
Qualification - not all businesses will be accepted for debt finance
Cashflow – debt repayments will eat into available cashflow every month
Types of small business finance
Bank Loans and Overdrafts, which will require a good relationship with the bank, a sound credit history and a compelling business plan.
Invoice Finance – the business is able to “sell” its invoices in exchange for cash upfront. This can be effective for a business with a poor credit history and needs an immediate injection of funds.
Venture Capital – Professional investors will invest a significant amount of money into the business in return for an equity stake. They will offer expertise as well as money but will look to take a significant chunk of the business.
Business Grants – can be obtained for specific projects and do not require to be paid back.
Short Term Business Loans - Can be extremely quick to arrange and useful where you can prove early repayment. Can be used fo VAT payments etc.
Business Credit Card – Can either be used as a tool to improve short term cashflow issues and manage business payments but can be risky in terms of creating a liability that’s difficult to clear and will affect the business’s credit score.
Managing Business Debt
Debt is undoubtedly a useful tool in some circumstances but they must be manageable and not allowed to spiral out of control. This will require good financial management. So cost reduction is a major factor along with keeping a constant eye on your financial situation.
Effective steps to manage debt
Create a rainy day fund – put cash into a deposit account to cover unforeseen costs so reducing reliance on overdraft facility.
Cut unnecessary spending – cost cutting by pruning the amount spent on office supplies, cleaning services downsize etc- – continuous review of costs is the key.
Increase income – offer early payment discounts, have instant sales to reduce stock levels.
Consider refinancing options – Shop around for alternative loans with better repayment and interest options. Pay off existing loans before they reach termination.
Negotiate with suppliers – ask for discounts using lower quotes from other suppliers or use your prompt payment history to negotiate extended payment terms. Team up with other businesses to achieve bulk purchases at a lower price.
Manage and boost your credit score to make it easier to secure finance deals.
Put financial management at the heart of your business
Managing the finances of your small business should not be an afterthought.
Aim to survive your first 5 years and ensure that you maintain this strategy. Review your costs and research alternative ways to add value to the business. Replacing permanent staff with part time solutions is a very effective and proven way to reduce costs.
Understanding the numbers that drive your business will improve your decision making and help you to identify when it is the right time to invest or put cost cutting measures in place.
By Ray Harrison
Ray is a Fractional CFO at The Finance People, with over 30 years experience in the field. Working closely with our clients, Ray provides fractional support for SMEs, helping them gain better control and understanding of their finances and strategising their finances for growth.