Every company, no matter its size or purpose, needs financial management tools to keep it on track. A common misconception, often across new businesses, is that a bank account with detailed statements and shoebox bookkeeping method is enough to track expense and profitability.
Volker Loetfering, a Business Loans Officer with Venture Niagara, expresses the importance of working with experts - “Having a good bookkeeper and accountant that can explain the financial ratios and point out errors or warning signs is ideal. If budget allows, a consultant can help to educate yourself.”
The predominant tools that need to be at the core of every business include budgeting, forecasting, and modeling. The budget shows what you expect to spend, the forecast predicts where you’ll end up and the model shows how you’ll get there.
When asked what common misconceptions business owners have about financial tracking, Rahi Tajzadeh, Chief Executive Officer of The Big Leaf, shares “Often there is a lack of understanding the key metrics in their industry, market(s), and internal operations and marketing. They often focus on a few of each, without necessarily understanding the impact of all the metrics, especially on financial KPIs. This can be, and often is, related to a lack of communication within and between organizations' departments, leaders, and employees. Lastly, a lack of candor can contribute to this phenomenon, which acts as a significant source of risk in any business.”
Your Budget
A budget is a plan for how much money a company is going to make and spend over a period. A budget can be a monthly, quarterly, or annual, but typically the most common is an annual plan, created with the goal of balancing income and expenses.
The process can be as simple as writing down all income earned by your business for the year, then finding out what you need to spend that amount on to operate your business (the expenses). “Make sure to include your own compensation, even if modest in the early stages,” says Volker.
Define what your expected surplus or shortfall will be. If you have an excess of funds left at the end of each month, use those funds to cover deficits incurred during previous months. If there are deficits at the end of each month, they should be put towards savings to offset any possible future deficit months.
A budget should be updated at least once a month to help you keep up with the flow of money coming in and out of your company. It also allows you to plan better because if there is an issue with cashflow, you'll know about it before it becomes a problem.
Expert Contribution:
Volker Loetfering, Business Loans Officer with Venture Niagara
A highly accomplished Business Development Manager, Volker holds 25+ years’ experience working in Europe and North America with extensive experience in business & economic development and financing and banking.
Your Forecast
A forecast is used to predict revenue and cashflow, generally created by looking at three things: the past, the future and assumptions about how certain events might unfold. “A cashflow forecast is paramount to all businesses, with a minimum of a two-year version that includes monthly revenue, COG (Cost of Goods) and expense details,” says Volker.
As you grow, build the habit of breaking your forecast into three sections: short-term (next two years), medium-term (next five years) and long-term (next ten years). Updates can be made monthly or quarterly, depending on the business and how quickly it changes, or if you have updated your budget or model.
Your Model
A financial model is a way of analyzing the balance sheet and income statement to determine how a company will perform in the future, predicting expenses, revenues, and cash flow for up to five years.
Created every 12-18 months, there are many factors that influence the timeframe of updates, including the size and complexity of the business and its recent growth. A financial model can be updated as often or infrequently as you want, but it's best to do so after you've reached a milestone in your company's lifecycle. For example, if you're just starting out and haven't made any sales yet, there may not be much to update in your financial model until you begin tracking revenue. If you've raised funds from investors or partnered with another company, put together an updated plan for how this investment will affect your finances.
The most financially disciplined businesses leverage all three tools in their planning and operations. They have a budget for day-to-day operations, a forecast for the future, and a financial model that captures current realities. They also have an accurate understanding of both the cash balance (current assets minus current liabilities) as well as the company's overall liquidity (cash balance plus marketable securities). “Always compare actual numbers with what you have forecasted – if you are doing better than what you projected, repeat and build on it. If you are doing worse, find the reason and course correct it,” shares Volker.
The effective use of these tools provides decision makers actionable information to make sound decisions on things like whether to borrow money, whether to go into debt, what kind of pricing they should set for goods and services, how much inventory they should buy or sell, how many employees they should hire or lay off, and so on.
“All three of these tools need to be an integral part of a full (internal) business plan. The business plan is an all-encompassing document that summarizes everything the business knows about their industry, market, opportunities therein, value proposition(s), marketing plan, operations plan, and financial plan. As such, a detailed model is built into the internal business plan (also called the Full Business Plan), as are a detailed budget, and forecasts (or pro-formas); all are necessary, and necessarily integral to risk mitigation and informed decision/strategy making.” Shared Rahi.
The right mix of these different financials provides business leaders with data to make informed decisions about future opportunities. While each tool has its own function, when used together they provide complete insight into a company’s financial strength and is an incredible aid when seeking growth opportunities.
“Funding and financial support is available for businesses. Get to know your lending partners: establish rapport with your advisor, branch manager, especially the head-teller at your bank. And be prepared with your document packages,” says Volker.
Expert Contribution:
Rahi S. Tajzadeh, CMC, MScM, BComm, CEO with KnowQuest Inc & CEO with The Big Leaf Inc
A Certified Management Consultant, Rahi’s background in entrepreneurship, consulting, and research brings a unique perspective and set of tools to better identify opportunities, craft strategy, and execute.
