This week we’re proud to introduce our guest blogger, Russell Whitlock, who’s helping small businesses understand their finances. As this is a burning issue for many start-ups and small businesses, we’re sure you’re all dying to read on...
Understanding your finances
To really get on top of your finances, you need to understand what’s in front of you. Information is power and in the case of your finances, it will help you make the right operational and strategic decisions.
The good news is you don’t need to be a financial adviser or accountant to do that. Have a quick read through the following and you’ll be on your way to a financial epiphany in no time...
1. What’s in my accounts?
The Profit and Loss account shows the sales and expenses over the last accounting year. The end result shows the profit for the period. This is the ‘bottom line’ that gets talked about and should be a positive number.
The Balance sheet shows a snapshot of what the company owns, but also what it owes and is owed at the end of the accounting year. So the balance sheet represents the value of the business.
These figures are often prepared much later than your year end and are a historical record of the performance of your business. In isolation, one year’s accounts do not tell much of a story. It is much more interesting to compare one year against another and see how things have developed over time.
If you are a limited company these accounts are also referred to as your statutory accounts and they must be filed with Companies House within nine months of your year end, but ideally as soon as possible.
2. Avoid surprises by preparing meaningful management accounts
Management accounts are prepared on a regular basis and they tell the current story of your business. They show what is happening chapter by chapter and in real time. Management accounts will also consist of a profit and loss account and a balance sheet, but prepared on a much shorter time frame, normally monthly. This allows a business owner to see how the business is performing now, not in 12 to 18 months time.
Good management accounts will measure key performance indicators, such as turnover and profit margin. They will combine this with non-financial information and provide meaningful measurement of things like profit ‘per region’ or turnover ‘per staff member’. This illustrates the story fully and gives you the information to influence the next chapter.
Measuring the performance of your business is the only way to make fully informed decisions on whether the business can afford to do something, should stop doing something, or should do more of something that you can see works.
3. Prepare a cash flow forecast
Cash is the lifeblood of a business. Just as your management accounts help you make decisions about your business, your cash flow forecast will tell you if you actually have the money to do it.
A simple spreadsheet model can be used for this as long as it clearly documents the amount of funds you are dealing with and when you should be receiving them or paying them out.
For example, your business bank account might show a surplus of funds, so you decide to put down a deposit on a new asset that will help you to expand your business. However, the following week you need to pay the VAT, PAYE and rent on your premises. Not being able to pay these will damage the business. A good cash flow spreadsheet will show exactly what is possible and when over a long period of time. This is called a cash flow forecast.
Being able to present good management accounts and cash flow forecasts can support you when you want to raise finances (business loan) to buy the assets you need to expand the business.
4. Mind the cash gap
It’s one thing to forecast, but quite another to manage what happens when things don’t go to plan. The cash gap is the real strain. This is the time or ‘gap’ between paying for goods you intend to sell and actually receiving payment from your customer.
Small businesses often get squeezed at each end. You need to pay up front, but customers often demand special conditions that give them longer to pay you. This increases the gap but in the meantime you still have bills to pay.
The best way to manage this is to ensure that you have clear terms and conditions for payment and enforce them, so customers do pay on time. After all, your suppliers will be doing the same with you. To minimise the gap further, keep your side of the deal with suppliers and pay as late as possible within the terms and conditions. If they give you 30 days, pay then and only then. Managing terms and conditions well will help build your reputation as a credible business.
5. Breakeven point
The breakeven point is when your fixed business costs (rent, software, etc.) and your variable costs (raw materials, commission, etc.) match your income. In other words, all the work you have done so far covers your costs but the next sale takes you into profit.
Calculating what and when your breakeven point will be is not easy when you are starting out. After all, you just want to get going! But it is important to establish what and when you think your breakeven point will be, so that you know what you are working towards and can manage your operation efficiently.
Breakeven is your first real goal and therefore it is motivating to keep a constant eye on your progress against this target.
About the author
Russell Whitlock is Managing Director of Russell Whitlock Accountancy, a dynamic Oxfordshire firm with a mission to provide a quality of service for small and medium sized businesses that is usually reserved for corporate enterprise. Before setting up his own practice, Russell worked with three leading accountancy firms in Oxford and London. As well as technical excellence, his experience has given him an acute sense of business success and what needs to be in place to achieve it. His expertise spans all areas of business services, financial compliance, taxation, audit, business plans and growth strategy.