Firms manage their financial performances to increase profitability, improve cash flows and reach growth, and for this, they involve in setting financial targets, deploying resources and controlling performances. A firm also reaches these milestones by creating an accounting system and appointing a professional team to perform financial duties. These financial duties include recording financial transactions, measuring profitability and managing cash flows. Besides, it uses an integrated software to manage financials, and this software is available online and sold with very decent prices. Importantly, the chosen software must fit your particular financial requirements, including cost-accounting needs, and can be easily integrated with other enterprise sections, e.g. production, inventory, HR and sales and marketing. Alternatively, you can develop a software system that exclusively suits your specific requirements. To better manage and improve your financial performance, I list below some thoughts and recommended actions:
Any planning cycle begins by setting some SMART objectives, followed with proper implementation. Financial targets include revenue, costs, profit, company net worth and cash flows. The value of these financial objectives includes enabling a firm to measure its financial performance and assess viability.
Estimate the break-even point
This process aims at determining the lowest level of sales at which a firm makes no profit or loss. This breakeven point can be calculated by constructing a chart and or using computing formulas, e.g. annual fixed costs divided by the gross profit per sold product or annual fixed costs divided by the gross profit margin. The breakeven point of any enterprise is influenced by the selling prices, quantity sold, fixed costs, variable costs, productivity, efficiency or technology advancement. The value of the break-even point analysis includes estimating the minimum level of profitable sales and checking if such a level of sales is attainable or not.
Estimate product costs
It is the process of working out the cost of products by conducting a cost accounting system. This system records all the costing transactions and estimates the product costs. Enterprise uses such cost accounting to determine expenses, estimate the product costs and price products. If costing and pricing are not proficient, it will be difficult for a business to plan, make a profit and survive. To estimate a product cost, management identifies all cost accounts, i.e. direct and indirect costs, and creates a cost centre for every product. Direct cost is an expense that directly relates to the product cost centre and includes factory expenses and material costs. Indirect cost is an expense that doesn’t relate directly to the product cost centre, and it includes administration and marketing expenses. After identifying the direct and indirect cost accounts, then you relate them to those established cost centres. According to this process, every production order is charged with its direct cost and proportional indirect cost based on a pre-set criterion. Most of the accounting soft wares nowadays are equipped with the cost accounting system, and they are easy to apply and estimate the product costs.
Project your financial statements
This involves planning your income statement, balance sheet and the cash flow for a fixed term, e.g. one year. Projecting income statement involves forecasting revenues, costs and net profit for the coming term, and projecting a balance sheet reveals forecasting the net working capital, fixed assets, loans and equity for the coming term. Projecting cash flows includes forecasting cash flow from the operation, investment, finance and equity. The value of projecting the income statement includes estimating the net profit or loss at the end of the term and balance sheet to estimate the net worth of the company. Projecting cash flows is essential for any firm to estimate liquidity and cash requirements.
Prepare financial statements
Financial reports tell the enterprise profitability, net value and cash flows, and they are recommended to be conducted monthly. This setup helps firms to monitor and control financial performance and improve profitability. To do so, a management stops operation for one half-day at the end of every month to count inventories, e.g. store and factory, record transactions, audit accounts and make the financial reports, i.e. trial balance, income statement, balance sheet and cash flow statements. These reports are then checked against financial targets and take necessary action to improve profitability and cash flows.
Improve profitability and cash flow
Profitability is the revenue surplus after deducting any expenses, and it shows management efficiency and business potential. Firms must keep their eye on profitability and innovate ways to increase it. The simplest way to improve profitability includes improving sales and controlling expenses. Improving cash flow involves encouraging sources and reducing uses of cash. Tactics to improve cash flow and profitability include improving sales, reducing expenditure, controlling the budget and cash flow, increasing efficiency and productivity or meeting customers’ needs.
Construct and control budget
This involves estimating cash flows and funds required over a fixed term, e.g. one year. Cash flow describes the sources and uses of cash for a year. Cash sources include revenue, decreasing net working capital, selling fixed assets and investments, taking loans or increasing equity. While cash uses include expenditures, purchasing, investing in working capital, investments, repaying loans and obligations, or paying dividends. The next step involves estimating any surpluses or deficits between sources and uses of cash and obtaining necessary funds. The value of budgeting includes keeping the firm focused on targets and ensuring sufficient control of cash flow. Any budget lists cash-ins, e.g. revenue, profits and increase in capital, the cashouts, e.g. expenditures and investments, and the net balance and funding. Management controls cash flows by checking any variances between the actual and budgeted cash flow and making decisions to eliminate the causes of any negative variations and encourage favourable variances. Tactics to eliminate negative differences include cutting expenditure, postponing spending, shortening credit facilities provided to customers or discounting selling prices to push sales up.
Access to cash
A firm needs cash to pay bills and invest in fixed assets, and for this, it projects the capital required and funding options for a fixed term, e.g. one year. As cash is expensive to get, firm estimates, schedules and prioritizes funds required to pay any operating and capital expenditures. Besides, it involves encouraging internal cash flows to pay expenses, as it is cheaper and easy to acquire. Cash flow can be internal, which comes from operating, investment and financing activities, and external including, loans, issuing equity shares, grants, mergers and acquisitions. Firms will need to decide on the best sources of funds and cost to finance their financial events.
This article is extracted from my new book- Mastering Enterprise Skills for Potential Entrepreneurs, which can be found on www.amazon.co.uk. If you want to receive more information about the book and our activities, you can register in our newsletter by using this link.
Prepared by: Munther Al Dawood