Article by Fedgroup
When an entrepreneur starts a new business, he or she has to be everything, including marketer, strategist, innovator, and yes, the financial manager. While it would be foolhardy not to see a financial specialist at year’s end, most small business owners simply do not have the cash to appoint a financial manager full time. The good news is that you do not need to be an accountant to be a financial manager. What you need is a good system and good discipline
For some businesses, financial management means going into a flat spin at the end of the financial year and trying to match sales slips with bank balances and inventory. Continual financial management doesn’t simply safeguard the business from going into panic mode at the end of the financial year, but helps the business owner to identify a crisis before it becomes unmanageable. A business is often sick long before the symptoms reach the bank account.
Generally speaking, sound financial management in a small or medium business consists of three pillars: a budget strategy, an administration strategy and a sales strategy.
The budget strategy for a business is important because it provides an instant snapshot of how it is doing. More importantly, it helps to map out a future armed with the knowledge of whether the business can afford new equipment, what the daily operating expenditure is, and to determine product pricing. Each business should have a one, three and five-year budget worked out, which allows it to plan for the purchase or replacement of its large equipment or other costly assets.
Armed with this knowledge, you can project turnover, which is a vital tool to determine the long-term viability of the business. For instance, if you are projecting a turnover of between R10 million and R12 million per year, but you are only making between R2 million and R3 million a year, the business plan needs a revisit as soon as possible. While business owners often open a business to live out their passion this is not possible if the business is not making money. A big component of this is getting the pricing right. If your product is not priced correctly, the more you sell, the quicker you will go bankrupt.
The administration strategy is as simple as it sounds and involves the filing process. But just because it is boring, does not mean it is not vital. Business owners should be able to locate every single financial document in the company at all times.
The sales strategy is part of financial management because any sales strategy in a successful business is attached to targets that can be measured, not in terms of how customers feel about the business, but in solid sales figures.
If you need R100 000 a month to survive, you know that you need to make R5 000 per working day a month. Then, if you know that you make one sale for every four people who visit your establishment, and you sell your product for R500, you need 40 people to visit your store daily to survive. You then know that you must create a marketing strategy that can achieve that target.
Determining your profits
Many businesses owners, especially when they first start out, do not know how much money the business has to generate to break even. To determine this, the business owner must know the gross profit margin of the business (see sidebar).
Through good financial management, it is possible to adjust the marketing strategy to support the needs of the business. In other words, how to make enough sales to break even plus a little extra to build in a margin of safety. The gross profit margin is used to determine the markup on products required to push past the break-even point.
Even small changes in mark-ups can affect the gross profit margin to a large extent. The same goes for discounts. If your markup on a product is 50%, for instance, and you give a 10% discount on that product, you need to sell 43% more of that product to get to the same gross profit margin. If a 10% discount is not going to drive those volumes, it makes no sense to provide the discount.
This example also shows why it is so useful to negotiate for discounts on our inputs, as even small changes to your input costs could have a massively beneficial impact on your profit margins.
Given the current competitive, low-growth environment, it is entirely possible that your product may fail to attract sufficient buyers, even at the lowest pricing level needed to break even.
This may not necessarily mean that the business is doomed to fail, but it does mean that the business owner needs to find a creative way to keep the doors open. In these instances, the business has to look beyond price levels to compete. Other options to consider are add-on products or benefits, or better after-sales service than the competitors. It may even be necessary to enter into a niche that is not fully exploited, by raising the price of the product and operating in the high end of the market, where volumes are lower but profits are larger.
How to calculate your gross profit margin
Gross profit margin is calculated as follows
(Revenue – cost of goods sold)
In simple terms, this means taking the money made by the business and subtracting the cost of making the products or service that were sold. This is then divided by the revenue again to determine the percentage of money made on each unit sold.
Therefore, if one makes R20 000 in a month by selling a product, but it costs R10 000 to make that product, the gross profit margin would be 50%. In other words, if R1 000 ends up in the company’s till at the end of the day, it would only have R500 in reality, because the rest would go towards covering the cost of making the product.
The cost of goods sold does not include payroll, taxation, interest payments and overheads. The profit margin therefore, needs to be large enough to cover all these costs, while still leaving something extra for future expansion or unforeseen events.