What’s your financial IQ?
You hear about it all the time. Yet another small business or start-up folding, another dream dashed.
The reasons behind why so many companies fail within their first years of operation are manifold but, working with hundreds of entrepreneurs, consultant Richard Weinberger notes it has a lot to do with financial IQ, or a lack of it.
He says "a lack of knowledge of basic finance is a common â€” and dangerous â€” mistake. Too many business owners don't understand their own finances, and have no idea what products or services make the most profit.â€
A basic understanding of finance and accounting is essential for business management but getting to grips on these topics doesn't require a degree.
In fact, the basics aren't too tricky, and if you can use a spreadsheet, you're on your way!
There are a range of tools you can use to boost your financial IQ but one good one, is Weinberger's book Accelerated Action to Maximize Profit which gives practical guidance for fledgling business owners think, how to use an income statement and a balance sheet, establish strong internal controls, and understand inventories, cash conversion cycles, and supply-chain management.
Weinberger recently shared some of his thoughts on the basics of small biz finance with Intuit.
Why is it important to understand your cash flow?
Small businesses may be profitable but not have much cash. They may have made sales on credit, they're servicing debt, they're paying for equipment, or maybe they've got lease payments.
If you know in advance that you may be short of cash, you can prepare. You could look for additional bank financing or try to modify the repayment terms on loans or other debts. But to do any of that, you have to be able to predict your cash flow.
What's the easiest way to understand your business's cash position?
The quick ratio. It consists of cash, cash equivalents, and accounts receivable divided by current liabilities. It does not include inventory, because it normally takes time to work though the sales process and be converted to cash.
What about invoices and collections?
One key component of cash flow is how long it takes your customers to pay you. If you analyse this and see that the amount of time it takes you to be paid is lengthening, you have a problem. You may be extending credit to customers who aren't credit worthy, or maybe you're not putting enough effort into collections. Shortening the amount of time it takes to be paid obviously improves cash flow.
Are there controls a business should have in place?
Absolutely and here are a few: The cheque signer and the cheque writer should not be the same person. Refunds to customers should be approved by someone other than the employee actually making the refund. When that isn't possible, refund receipts should be reviewed daily.
Any other advice?
One of the best things a small business can do is to do a critical, honest self-evaluation of the business â€” a SWOT analysis. That stands for "strengths, weaknesses, opportunities, and threats.â€
I tell people that this is not the time to be a cheerleader for your company. What are you doing that's good? Let's continue to do that, and let's also look at the weaknesses and see how we can improve them. Ask: What are those competitive liabilities that let our competition do better than we are?