By Neil Loveday
“Welcome to the accounting department, where everybody counts”. OK, there aren’t going to be too many accountants quitting the profession for a career in stand-up comedy – but they do bring skills to the table that your business may currently lack. Most entrepreneurs don’t have a background in accountancy – and a lack of financial literacy can be costly. You might even say: “It’s accrual world” (see what we did there?).
That’s not to say, however, that business leaders lacking specialist finance expertise should simply opt out. Entrepreneurs who have a granular understanding of what’s going on in their businesses stand a better chance of long-term success – and avoiding short-term traps that often catch out the unwary – because they can plan and operate with greater certainty. Here’s are six financial yardsticks every business leader should keep a very close eye on.
Profitability, whichever way you measure it, depends on revenues and costs: you need visibility of both. Your order book will tell you about the former: the value of orders placed for a given period ahead, the value of production completed, and the sales you have invoiced for. Costs, meanwhile, are incurred throughout the business and must be measured against revenues.
It’s one thing looking at what’s happened in the past, but business leaders also need to understand what lies ahead, with realistic budgets that are based on your expectations about future sales and costs – and adjusted for changes you anticipate. That might be anything from a rise in the cost of raw materials to plans for expansion.
What is your business owed and how quickly are your debtors paying? Unless you’re constantly reviewing your sales ledger, you won’t be able to answer these crucial questions – and the effect on cashflow of a bad debt problem that gets out of hand before it is spotted can be disastrous.
Think carefully about how you manage debt: both the payment terms you offer and how and when you invoice customers. In an ideal world, issue invoices as soon as work is completed because the timing of invoices can have a substantial effect on cashflow. Whatever terms you offer, most businesses tend to pay at the end of the month following the invoice date - so an invoice dated 31 March would be paid on 30 April whereas a 1 April invoice would not be paid until 31 May.
When customers don’t pay in line with your terms, issue a statement – a reminder to pay – as quickly as possible. Some businesses routinely fail to pay until they’ve received one.
Keep just as close an eye on what your business owes as what is due to come in: review your bills on a monthly basis and think about how you pay them. Delaying payments for too long may jeopardise your relationship with suppliers, for example, while paying too quickly can be damaging to cash flow.
As with invoice generation, timing can be crucial: if your suppliers require payment at the end of the month following the invoice date, you may even want to consider avoiding ordering goods or services towards the end of the month, so that you’ve got longer to pay.
If you’re keeping a close eye on credit and debt, you’ll already be managing the working capital you have in the business. You may be alternating between small credit balances and minor overdrafts – assuming you have the right banking facilities in place – but if your cash flow is more volatile than that, you may need to think about how to manage that.
For example, there may be more affordable ways to manage large short-term borrowing requirements. You may need to think harder about how payments are scheduled – or even to consider financing solutions such as invoice finance.
If you’re regularly sitting on large cash balances, on the other hand, you need to find ways to make this work harder for you. Shifting cash into deposit accounts paying interest is one option – but is your business investing enough for its future?
Stock management is an art as well as a science: how much you need at any one time will depend on the nature of your business. Hold too much and you’ll have to pay out for storage, as well as facing the risk of getting left with unsold assets. Hold too little and you may not be in a position to meet all orders.
Once you’ve settled on a particular level, monitor what happens to stock carefully. If excess stock builds up, this may be a warning sign that sales are falling.
Is the capital employed in your business working hard enough? You may be able to increase revenues without investing more capital, or even to make your business more efficient from a capital perspective by taking on some borrowing.
For example, if you have expensive capital equipment, are there times when it is lying idle? If demand allows, extra shifts could be one option – or even leasing spare capacity to another business. It might even make sense to sell off the machine and lease only the production time you need.
Neil Loveday is part of PwC’s My Financepartner, a cloud-enabled accounting and business support service that helps ambitious SMEs grow.
This blog is part of a series from My Financepartner. My Financepartner is a new accounting service for small and medium-sized businesses that puts you in control. You choose the services that you need, module by module, and we'll deliver them. Contact us at email@example.com