In this post on the key reasons businesses fail in financial management, read about the importance of sound business financial management, the critical role of financial literacy in financial management, and the common pitfalls of business finance management and how you can avoid them.
Whether your business is a small one-man operation or a multi-million-dollar outfit employing hundreds, every business shares one major concern; managing money. Effective business financial management is crucial for survival, growth, as well as maintaining competitiveness within your industry.
Running a successful business takes a lot more than just implementing a good idea. You’ll need to have a sound financial structure that is able to generate profits and keep your operation going. Small businesses, because they’re more fragile and vulnerable, need to be especially cautious with their financial matters from the very start to ensure they get through the initial teething stages.
Proper financial management ensures that your business utilises its resources effectively, maintains competitiveness, fulfils stakeholder commitments and maintains financial stability in the long-term. It should, therefore, be prioritised as a key business process and also be included in all your business plans.
Knowledge is key
Finance, as you might have figured by now, is quite a technical subject. This means that there is no room for guesswork when it comes to the financial management of your business. As such, you will need to educate yourself on various aspects of finance – the basics at the very least.
For starters, you should educate yourself on how to analyse financial statements if you’re not able to already. This very critical statement tells you everything you need to know about your money – its origin, the hands it has gone through and its final destination.
A financial statement contains 4 important details:
- Income statement. This shows the revenue earned in a specific period.
- Cash flow statement. It’s a statement detailing the operating activities of the business including investments and cash in/outflow.
- Balance sheet. The balance sheet reflects your company’s liabilities, assets as well as shareholder equity.
- Statement of shareholder’s equity. This statement provides information on the company’s financing through preferred and common shares.
The ability to create – or at the very least, understand – financial reports forms the basis of effective financial management within any business regardless of industry. So, whether you take a course in a local business school or learn by yourself through online tutorials, having this knowledge will determine how well your business financial management works out.
Reasons why businesses mismanage their finances
Without financial knowledge, business financial management can be overwhelming and a bit of hit and miss. Failing to get financial education is, therefore, the main reason why most businesses cannot manage their finances – because if you cannot identify the problem, how are you going to fix it?
While financial illiteracy is the number one reason why many businesses cannot manage their finances, there are other key reasons that result if financial mismanagement.
- Mixing business and personal finances
Any seasoned entrepreneur will attest that this is a sure route to financial mismanagement in any business. That’s because without proper financial separation, things can get muddled and cash will inadvertently get syphoned off either from your business to your personal expenses or vice versa.
Whether your business is a sole proprietorship or a larger operation employing some personnel, you must create a separate bank account for it. Your business should also have its own separate credit card linked to the business account on which you can put business-related expenses.
Additionally, you need to ensure that you pay yourself a salary. This will ensure that you don’t take up all the business’s profits and keep the money to yourself. As such, your company will have cash reserves to keep the lights on when things get tough, deal with emergencies, and invest back for continued growth.
- Bad accounting
It’s very difficult to keep clear, useful financial records if you don’t have a good accounting system in place. And while establishing an accounting system is a major step towards sound business financial management, the system will be of little use to you if accounts are not consistently updated.
Set up a proper record keeping system and update it regularly as this will help you keep track of your debtors and creditors, expenses, and even make it easier for you to apply for additional external funding if you need to.
Ensure you consistently keep track of your business’s financial progress. Make it a habit to monitor, on a daily basis, the amount of money in the bank, your sales as well as your stock levels.
- Poor cash flow management
When it comes to the short-term survival of a business, cash flow is more important than profitability. Not having money at hand to cover day-to-day operating expenses or an unforeseen emergency can cripple any business. Because of this, cash flow management needs to be prioritised when managing business finances.
The key to maintaining a positive cash flow is knowing your day-to-day costs. Find out the minimum amount of money your business requires to survive in your typical payment cycle and make sure that your cash reserves never go below this. This way you’ll have enough cash reserves to keep the lights on if customers fail to pay up on time.
You’ll also need to ensure that your debtors pay you on time to avoid financial constraints. You can convert debt into cash more efficiently by expeditiously issuing clear and accurate invoices to customers, following up on payments, and offering rewards (such as cash discounts) to customers who pay quickly.
Business Credit Reporting can help with cashflow.
- Inadequate planning and budgeting
Not having a financial plan for your business can be compared to driving a vehicle while blindfolded – it’s hard to pull off, to say the least. While it’s difficult to plan for every little issue that comes up, you should have a general plan that outlines your financial goals and objectives in the next five to ten years. This should include revenue projections, anticipated large capital expenditures, predicted financial pitfalls and so on.
With a sound financial plan, you’ll not only have a yardstick to measure progress against but also the basis for your annual budget formulations. Having a sound budget is critical for effective cash utilisation – a key pillar of sound financial management.
- Poor cost control
The general rule in business is that you have to spend money to make money, but this does not mean wasting it. If you cannot keep your costs in control, even a billion dollars of revenue will not keep your operation afloat for long.
Analyse your financial statements, financial plan and budget to prioritise expenditures and to find out your biggest cash draws. Once you have everything mapped out, eliminate all unnecessary expenditures and work to reduce the ones that cannot be avoided.
Improving operating efficiency is one of the easier ways of reducing costs. So, streamline your processes for efficiency and effectiveness. Also avoid fines, penalties and interests by filling your tax returns and making credit payments on time.