Question: What are the best tools for a manager to use in projecting, monitoring and controlling costs and revenue for improving financial outcomes?
Answer: The subject of Financial Management in the Small Business is usually focused around the means of getting funded in the first place. But it is equally important to manage the use of funds in the business. The only way lenders will have their loans paid off or equity lender see their investment grow is through effective financial management after funding, in other words the use of funds. In this article we will examine three methods of financial control that will help you manage your funding effectively.
Control by Managing Cash Flow
The cash flow system is typically a monthly management system which starts with an accounting of available cash. A projection is then made of the cash that will be available during the month in addition to the opening balance. Incoming cash will consist of payments for services rendered, loans, equity investments, grants, and any other source from which cash is expected to be available. The total of opening cash plus projected incoming cash for the month represents the available cash to pay bills during the month. We then deduct cash outflows, such as salaries, materials, overhead expenses and taxes that will have to be paid during the month. When all income and expense items are totaled, what remains is the month ending balance of available cash for the next month. The process is repeated for each successive month of the planning period, typically one year. It is critically important that the month ending balance be of sufficient size that when incoming cash is received, and outgoing cash is paid out, that a positive balance remain available to the company for the next period. Also since both incoming and outgoing cash totals are projected (estimated) at the beginning of the month the estimates should be audited at the end of the month in order to be made more accurate on the basis of experience as opposed to estimation. Effective management of cash flow is a key requirement for success in the management of any business.
Control by Managing Operations Above Breakeven
The breakeven point for a business is the point above which operations are profitable and below which the firm will sustain losses. Computing the breakeven point can show not only the results for the business as a whole, but it can also be utilized to compute breakeven points for individual products and services. The formula is utilizes the accounting concepts of sales price and gross margin per unit and total overhead costs, to find the volume level that will yield breakeven operations. If for example, the firm earned $5.00 per unit sales (gross margin can be seen from an example using sales price of $10/unit minus production costs of $5.00/unit yielding $5.00 per unit gross profit and therefore 50%) and allocated overhead was $5,000 per month, the $10,000 of sales volume would result in breakeven operations for that product. (It is assumed that each product or service would share an allocation of overhead costs, based on criteria such as floor space utilized, sales time needed to close an order, Etc). Of course total company breakeven would require summing up all products and services made or purchased and the gross profit on each would have to be calculated, and all overhead costs would have to be allocated in order for the firm to determine system wide breakeven. In the case cited above, on a total company basis with a monthly overhead of $50,000., gross profit of 50%, unit sales price of $10., sales at the level of $100,000 monthly would yield a gross profit of $50,000 monthly which when applied to monthly overhead of $50,000 would produce a breakeven point. This calculation is particularly important for the firm to be able to recognize the products it is making money on and those on which it is losing money. Then the losers have to be upgraded to profitable operations, and the winners (profitable products) have to be expanded to increase company profits.
Control by Ratio Analysis
Ratio analysis is based on the fact that in a profit and loss statement, we can use gross revenue as a baseline, and all costs associated with that level of volume can be calculated as a percent of the gross. The first calculation is the gross profit, which was referenced above as the sales price minus the cost of production or purchasing (if we are working with a merchandising corporation). This can be converted from a dollar figure to a percentage, that (as per the example above, dollar figure of $5.00 and also 50%)
From the gross profit we now calculate the percentage individual overhead costs related to volume. If volume is $10,000 (per month as an example of a very small business), and rent was $1,000, then rental is 10% of sales. All the rest of the overhead can be apportioned in that manner, As well as the product specific costs of production.
What we are looking for is relationships or ratios that one figure bears to another. Our goal, of course is to minimize costs and maximize revenue, so ratios can be used as targets such as .075% of sales at the rate of $10,000 (sales volume per month) would mean reducing rent to $750/month while of course maintaining sales volume at the level of $10,000/month.
Ratio analysis works best with accurate financial data especially financial statements both profit and loss (income statement) and the balance sheet. It is very important to be able to compute both dollar totals and ratios in order to maintain effective control of your financial status.
Summary: Tools to Improve Financial Outcomes
In this article we have shown how using three basic tools can help improve financial management. Cash Flow projection and analysis can ensure that the funds to operate the business will be available when needed. Breakeven analysis can help managers focus attention on high profit products and services while highlighting less profitable items fir improvement or elimination from the firm’s offerings to its customers. Finally ratio analysis can show relationships between elements of cost and revenue thereby enabling the firm to plan and monitor its operating results. SCORE mentors can help you utilize thee powerful tools to help improve your business results. Call for an appointment today!