Introduction

Business is the foundation of the world economy. Unfortunately, many companies fail for financial reasons. In business enterprises, the failure rate is extremely high, especially in the early years. This article highlights some of the key factors that need to be addressed to minimize the likelihood of financial failure in business. The discussion takes place under the following headings:

• Financial planning;
• Financial management.

Financial planning

Financial planning must be done on an ongoing basis in any business. It should start with the conception of a new company and continue until the company is closed or merged with another company. However, planning is pointless if the management of a company does not have the necessary business and financial acumen. Management must understand the basics, even if the actual financial planning is outsourced. This includes an understanding of financial statements, cash flows, and financial ratios. They need to know if the business is making enough profits, if there is sufficient liquidity and solvency, where potential problems lie, and how they can fix them.

Financial planning should include the following activities:

• Sales planning. Without sufficient turnover, no company can survive in the long term. The equilibrium sales must be known. Sales targets should be realistic and support the necessary growth and profits.
• CREDIT Policy. Credit is generally provided to achieve required sales. However, this is done at risk (from non-paying debtors) and costs money. Therefore, it is extremely important to have a proper credit policy that you strictly adhere to. The policy should include what types of individuals or institutions will obtain credit, under what circumstances, how much they will qualify, the guarantees that must be in effect, the terms of the credit, and how the payment (and the lack of it) will be managed.
• Prices. Pricing is a science in its own right. Prices that are too high deter customers and prices that are too low reduce the profitability of the business. Therefore, prices should be competitive. The gross margins of a company are the direct result of prices. Gross profit is necessary to cover the financial obligations of a company and to enable growth. The profitability of different products and services needs to be analyzed and should only be kept as part of the offering if they provide sufficient margins or are of strategic importance.
• Cash flow projections. Various aspects of a business impact its cash flow. Many seemingly healthy companies fail due to cash flow problems. It is of the utmost importance for a company to plan sales and expenses and, especially, when they are made. The money that must be received in 90 days cannot pay the running costs.

Financial management

Business finances must be continuously monitored and managed. Problems must be identified and rectified as soon as possible. Being proactive now can make a big difference later.

The financial aspects of a business that must be managed include the following:

• Financing. You need to finance capital expenditures and working capital. Planning a business and its cash flows should highlight the need and timing of financing. Financing can be done through current shareholders, through the sale of new shares or through external financing. External financing is expensive and risky for the company. It can cause the financial downfall of a business when commitments are not met. On the other hand, it can allow for much faster growth. Financing should be part of a company’s broader strategy and in line with the risk profile of the business.
• Stock Holding. Inventory should be at optimal levels. Insufficient stock (with regular stock outages) can negatively affect customer relationships and decrease churn. Having too much inventory is expensive and risky (due to obsolescence and theft). Inventory levels must be determined and managed professionally (using inventory optimization models that take into account the importance of a product, stock turnaround time, and lead times when ordering a product) .
• Accounts receivable. In general, it is important to provide credit in today’s economy. However, the difference in debtors who pay on average after 30 days or 60 days can make the difference between success and failure (this is clearly reflected in the cash flow projections). Debtors should be analyzed based on their seniority and debtors who do not meet their credit conditions should be diligently monitored and, if necessary, their credit allocations should be revoked.
• Business growth. A business can only grow as fast as it can generate enough money (through profit, investment, or financing) to fund its working capital. Growth above this is not sustainable and, in the long run, will lead to the financial failure of a business. The sustainable growth rate of a company is determined by a combination of its profitability, efficient use of its assets, financial leverage (ratio of debt to equity) and retained earnings that are maintained in the business. This rate must be closely monitored and its various determinants effectively managed.
• Expenses. Expense items must be budgeted. Substantial deviations from real vs. You need to explain the budgeted figures and filter their effects into new budgets, cash flows, and other financial projections. In practice, times of rapid growth and good economic conditions are dangerous in the sense that there is a tendency to increase expenses too much during this time. So it can be difficult to curb expenses (especially wages and salary-related ones) in times of economic downturn.
• Financial coefficients. Proper use of ratios can help management identify problems and take corrective action. It is important to know the profitability, liquidity and solvency of the company, to know where the potential problems are and then how to correct them. The ratio analysis should be done monthly (if applicable) and should be compared with other companies in the industry and especially with forecast and past figures (previous period and same period last year).
• Cash flow. Everything about the success or failure of a business tends to impact cash flow. Cash flows should be analyzed for potential problems and should be adjusted monthly. By ignoring cash flows for a few months, a small problem can easily turn into something that is out of control.

Resume

This article highlights just a few, but very important, issues that need to be planned and managed within a company to reduce the risk of financial failure. In general, the most important issue to manage is the cash flow of a company. All income and expenses and actual times are reflected in a cash flow statement. There is a causal relationship in both directions between all the aspects (which are mentioned in this article) and the cash flow of a company.

Copyright © 2008 – Wim Venter