A financial understanding of your business is critical in ensuring that you remain profitable. This series is built on the concept of Finance For The Non Financial Leader. Why then do so many people falter when asked what is your gross profit? Or what should you be allowing for costs against a gross profit? What is cash flow forecasting?
Finance is not just for the financial manager. Achieving and maintaining financial stability is an important part of any company’s success, and it’s not something that you, as a business owner, founder or leader can leave to someone else.
In this sequence of posts – Finance For The Non Financial Leader, we’ll cover the basic terms you need to understand in order to keep your business on a solid financial footing.
We’ll also discuss how you can use these terms to make sure that your records are accurate and up-to-date, and how your directors’ responsibility in keeping accurate records can help ensure that your company stays in the black.
Finally, we’ll go over what happens when there isn’t enough money coming in or going out of a company—how do you deal with cash flow problems? And what happens when there’s too much money coming in? Is it always a good thing?
A financial understanding of your business is critical in ensuring that you remain profitable. The more you know about your company’s finances, the better able you’ll be able to make informed decisions about how to maintain a healthy balance between income and expenditure.
We will discuss the importance of understanding your business’s financial situation so that you can identify potential problems before they become too serious.
It’s also important to understand the mechanics of how money flows into and out of your company. This will help you make sure that your finances are in order so that you can get paid for the work you do. Here, we’ll discuss some basic accounting terms and principles, as well as how to keep track of where all your money comes from and goes.
Cash is King
The first rule to remember is that cash is king.
Cash is money that you can free up immediately in your business and often is held in a bank or savings account.
Cash flow is the amount of money that flows into and out of your business. You need to ensure that you have enough cash coming in so that all of your expenses are covered.
If you run out of the cash needed to run your business and cannot satisfy the people that you owe money to, you are insolvent. This happens when a company can’t pay its bills or take care of other financial obligations. If there is not enough money coming in, then it’s time to re-evaluate how much money you spend on things like salaries and rent.
You can therefore understand why Cash is King
How does cash come in and leave the business? An essential for the non financial leader.
Cash comes in usually in the terms of income (sales) and Cash leaves the business as an Expense. The following equation is often referred to
Income – Expense = Profit (Loss)
This calculation can give you an immediate picture as to the profit or loss that is being generated by the business.
If Income is greater than the expense, then you are in a profit situation.
- If Income is less than the expense, then you are in a loss situation.
Whichever situation you are in, the figures tend to roll from month to month. From this, you can predict what the future cash flow forecast is. The cashflow forecast is how much money you are predicting to be n the business when you have taken into account all the Income less Expenses of a period of time.
Lets work this through with an example.
You have just sold Widget X to a new client for $100. It costs you $34 to make the Widget and $6 to ship the product to the client.
Your profit is therefore $100 – ($34+$6) = $60. This is termed your GROSS profit. In this example, the gross profit is 60% of sales.
The GROSS profit is the cash that you make when you take into account any costs incurred when you make and sell this product.
It is likely that you are paying yourself a salary, perhaps rent a building and have a loan to repay when you purchased the equipment. These are all fixed costs and ultimately still need to be deducted from the Cash or profit that you have generated.
When we take a proportion of this at the product level (say $35 per widget) – your net profit is $60 less $35 which is $25 or 25%.
It is really important to keep your net profit positive else you will be losing money and will eat into any cash that you have in your bank.
Importance of keeping records – an imperative for the non financial leader
Importance of keeping records
an imperative for the non financial leader
Can you imagine the chaos that would ensue if you didn’t have a record of all the costs associated with producing and selling your widget?
You wouldn’t be able to know how much profit was made, where it was made or what product lines were profitable or not. This is why it is so important for non financial leaders to have access to their own finance functions in order to ensure that they are getting the information they need when they need it.
When you are a new business, it is important to keep records of all your transactions. It allows you to track the financial health of your business over time. This information can also be used by external parties such as investors, banks and accountants. They will want to see that you have been able to generate positive cash flow which means that they know that they will get their money back when they invest in your company.
Aside from the chaos that could be caused by not keeping accurate records, there is an obligation to do so from the tax office and companies house. If you cannot demonstrate this, you could be struck off as a director and receive fines.
Solution : Software packages offer a helping strategy for non financial leaders.
Luckily, a lot of the financial data that you need to track can be found in several online accounting packages.
I have been using Xero for many years as this not only ‘forces’ you to keep accurate records but also aids in the submission of tax records. This is a very easy to use accounting software that allows you to easily create invoices and manage your cash flow. It also gives you access to reports that show how much money is coming in and going out of your business.
As a non financial leader myself, I rely on Xero and processes to ensure that I understand the state of my business(s) at any moment in time, keep accurate records and submit what I need to to tax and other government organisations.