Privately owned businesses are not renowned for their astute financial management … and that is really quite absurd given that it is one of the fundamental reasons for being in business in the first place.
To be complete it should be stated that a business has to be across all core functions to be successful: offer to the market, marketing, sales, operations, planning (direction and strategy), people, I.T., administration, customer experience, risk management, premises/equipment and governance. Businesses tend to be good, first and foremost, at producing the goods and services to sell. That is often the basis of why each business is started.
This article looks at six big mistakes privately owned businesses make on the finance side of the business and why they make them … in order to help prevent them in future. Each of the mistakes listed includes reasons for why/how they occur.
Poor cash flow
- Cash Flow is not tracked … only the cash balance is watched. This causes lateness in picking up problems. Cash Flow reporting is a must, at least on a monthly basis if not a fortnightly or weekly basis.
- Cash Flow budgeting is not done. This should be done at least for the next 30 days. Businesses argue that it is too difficult to predict and/or too costly to do cash flow budgeting … that is a nonsense given that a lack of cash is the single biggest reason for business closure.
- Poor cost control. See below.
- Lack of Profit & Loss budgeting. It is (falsely) argued that it is just guesswork so why bother. The point is that budgeting forces planning and therefore decisions to be made. It is more about that than predicting results.
- Lack of Profit & Loss reporting. Lack of accurate profitability reporting, sometimes being as late as when the external accountant finalises the accounts or tax return! That is way too late for necessary adjustments to the business. Profitability reporting has to be at least monthly.
- Failure to make tough decisions (early enough). Waiting too long and suffering the financial consequences longer than is necessary.
- Chasing sales rather than profitable sales. Business is not about getting sales; it is about securing profitable sales.
Poor business value or inability to sell the business
- Not knowing what the approximate business value would be if it was put on the market today. This too often causes an absence of decisions to improve business value. Many business owners argue that they don’t intend to sell the business (yet or until well into the future). The fact is that privately owned businesses have to change hands (even to the next family generation) at some stage or be shut down. That means that business value does matter, irrespective of how far into the future the event will be or what it will be, so managing to its value is a key component of running any business.
- Running the business ostensibly well but failing to realise it could/will be unattractive to anyone else, for a host of possible reasons, e.g. dependence on one or a few key people who could/would leave upon sale or shortly after, unattractive industry to be in.
- Poor record keeping and therefore inability to demonstrate business value.
- Lack of formal contracts with suppliers or customers.
- Dwindling industry now or in the foreseeable future. This is happening more to businesses/industries today due to global competition, technology and innovation, and online selling.
Inability to get money out of the business
- Profit and cash are two different things, of course. Unless owners are content to leave all/most of the profits in the business along the way and only get cash out at the point of selling equity, it is clearly preferable to run a profitable business that is able to pay healthy dividends to its owners. Accidentally not being able to do that can represent poor cash flow management and poor planning. (This is clearly different to not taking dividends on a deliberate choice to reinvest in the business).
Poor rate of return on capital
- Not knowing the rate of return. Why would anyone own and run a business, without knowing the rate of return on their capital? That is surely one of the most important measures of business success.
- Not knowing how to measure the rate of return on capital. Accountants give several different ways to do this but, for us, there is one that is most important: profit compared to the net realisable value of the business (its saleable value). This, we argue, is the most relevant because it highlights the opportunity cost of owning and running the business. It should be measured in before and after tax terms, i.e. net profit before income tax, net profit after income tax, net realisable value before GST, net realisable value after GST. For example, net profit after income tax of $70k on a net realisable value after GST of $1,000,000 is a 7% ROC net of tax. The question then becomes is that a good return compared to what else could be done with the $1,000,000 if the business was sold? This is surely the most important way to measure ROC.
- Remuneration paid to owners working in the business must be recorded at commercial levels. Too often owners over or under pay themselves compared to commercial levels for the roles they perform and this would obviously distort the return on capital.
Poor cost control
- Lack of measurement of costs
- Inaccurate measurement of costs.
- Untimely measurement of costs, i.e. getting data too late to take remedial action.
- Lack of unit measurement of costs, i.e. only measuring total costs and not costs per unit of production, per unit of space, per head, etc., all of which are important measures.
- Untimely reporting of costs, i.e. not receiving and/or analysing cost data quickly enough. This causes slower rectification of problems.
- Slow reactions to high costs, i.e. noticing high costs but not reacting quickly (enough).
- Lack of awareness of alternatives to existing costs. Alternative to high costs can often be found if they are sought.
If a business is guilty of even one of the above six points it will suffer, significantly!
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