Don’t let limited knowledge of business finance management hinder your chances of success. Do you know the different types of financial statements? Can you manage budgeting or financial analysis? Can you efficiently manage the company’s cash flows and assess the profitability of different projects? Are you overly dependent on other financial specialists for critical financial decision-making?
Whether you are a one-man operation, the CEO of a business, or even just a part of a business’ managerial team, business finance management must be ingrained in your skill set. Finances are arguably the most important while at the same time the most complex part of running a business. Knowledge of basic economics, and then on top of that knowing how to do your own accounting and business finance management make you self-sufficient.
While we highly advise hiring a professional for this role, that is no reason for you to not be familiar with business finance management. One must only leave to professionals what one cannot do himself but verify the legitimacy of when done by another. If you can’t even master basic financial statement comprehension, you leave yourself exposed to being potentially hoodwinked by your accountant, or any cog in the machine under you involved with the finance and accounting function.
Whether you are a manager wanting to master business finance management basics or you just need to refresh your knowledge, this guide will help you master the basics.
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The Importance of Business Finance Management
Readers looking for a simple refresher can skip to the next segment, as we will now be discussing the importance of business finance management and why it is an incredibly lucrative subject to master the basics of.
For starters, business finance management is all about control. Controlling your finances, limiting your costs, raising profitability, and all such matters while minimizing risk involved
You can set your business on the road to success by leveraging business finance management techniques. Robust business finance management leads to developing a concrete future game plan based on financial data, leading to better business decision-making. And with decisions made based on data-driven financial forecasts comes enhanced profitability and cost control, which all contribute to the long-term growth and success of the business. And all of this is doubly important now because of how volatile the economy has been since the start of the decade, not to mention the financial uncertainties of the future due to the miraculous rise of A.I and it’s effects on the business world, especially in questions of cost control.
Let’s get started then, shall we? We’ll start with financial statement comprehension and analysis, then move on to the practical stuff like budgeting and financial risk management.
Before we dive into financial statement analysis, it is important to acknowledge that comprehending the data on the various kinds of financial statements is a subject worth its separate publication to be given justice. This article will focus more on the strategic aspects, so readers interested in the nitty gritty of financial statements can visit this article to get an in-depth explanation from our EA experts.
Moving on to the matter of financial statement analysis, it is a process that entails analyzing Key Performance Indicators (KPIs) and identifying financial trends. This helps to assess the company’s financial health and performance. There are many different ways to perform financial statement analysis, such as horizontal analysis, vertical analysis, ratio analysis, etc., but the ones we are concerned with is ratio analysis, as it is the simplest kind of analysis and can provide a lot of information on the business’ financial health and performance without needing advanced data analysis skills.
Put simply, ratio analysis is where you take the line items in the financial statement and plug them into pre-existing formulae to convert your business’ financial data into meaningful information. Think about it, the dollar amount of your revenue doesn’t tell you much about your business besides what you already knew, but when you plug that amount into the gross profit margin ration you end up with a percentage that clearly shows you your profitability.
Similarly, there are tens of hundreds of different financial ratios out there, each helping you learn something or other about the business. For the sake of brevity, we will only be covering the most relevant financial ratios that should be basic knowledge for any entrepreneur or finance professional. For curious minds looking to learn more, the Corporate Finance Institute has crafted a thorough guide on all of them.
The gross profit margin tells us how profitable the company’s core operations are. It measures how much percentage of revenue is left after deducting the cost of goods sold. When we measure gross profit margin over a certain period we can identify any cost inefficiencies, and evaluate the impact of pricing strategies or changes in the product mix. It is also helpful to compare the company’s gross profit against the industry standards to gauge competitiveness.
Your Net Profit Margin is the percentage of revenue that remains after you deduct all expenses, including taxes and interest. The net profit margin is a great tool to measure the business’ profitability, and identify where expenses can be controlled to boost profit. On top of that, your net profit margin is a very clear sign of the business’ current financial health and long-term growth prospects. Suppose your net profit margin is looking healthy i.e., your profits are enough to not only sustain the business’ current expenses but also allow for further investment in the business for growth and expansion, then you have nothing to worry about and can safely continue growing.
This KPI clearly shows how the business’ asset investments are converting into profits. It shows you how efficiently your business is leveraging its assets to generate returns, and the higher the ROA, the stronger your financial performance.
A poor ROA suggests that changes need to be made. Perhaps your product is costing more to produce than it is worth, and it may be time for a new product launch. Maybe you have some operational expenses causing your ROA to suffer, and you need to start optimizing your business processes and try to bring your ROA up. You can also compare your operational efficiency by comparing the ROA before and after implementing process changes, which lets you see what worked and what didn’t, and can be used for future decision-making.
As the name suggests, the current ratio helps measure how much liquidity is available in the business in the short term, or the business’s ability to repay its short-term debts.
This ratio is important because it shows you how financially healthy your business is and how well it can survive a potential crisis. A current ratio over 1 is a clearly indicates that even if things go wrong, the business can still reliably cover its liabilities and keep going.
However, a high current ratio is not the end-all- be-all. It demonstrates how well you can pay back your debts, but it does not indicate your financial performance.
This is why the current ratio must be used with other ratios to accurately represent the business’ financial position.
Operating Cash Flow to Net Sales Ratio:
This ratio is a KPI demonstrating the business’ ability to generate cash flow proportionate to its sales volume. This is an important one because maintaining positive cash flow is very necessary in today’s business landscape. You must regularly evaluate your business in terms of this KPI to ensure that any underperformance can be fixed in a timely fashion before things reach a breaking point.
This number should remain the same as sales rise, otherwise, there may be an issue in the cash flow that needs to be addressed.
With all these financial ratios in your tool belt, you end up with much information about your business. So, the next logical step is of course to start leveraging it for various business finance management activities.
Every business needs to budget. The budget is the breakdown of how you will spend your available resources for a time. Typically, businesses devise budgets on a monthly or yearly basis, but frequency largely depends on the industry and type of business.
Budgeting involves leveraging financial statement data to estimate future business performance and subsequently generated income, which can then be factored into the calculus for determining appropriate business goals based on the estimated expenses.
For example, you own a perfume brand. Your business has consistently been generating upwards of a million dollars every month. This means that you can reliably assume that at the very least your income will stay in that average ballpark if things remain the same. Alternatively, you can account for potential market changes and other external factors and project your income. For the sake of explanation, consider that your projected income for the next month is one million. After calculating how much money you will have available to spend, it’s time to factor in your expenses. Say your operation costs are about half of that. That leaves you with $500,000 to spend on business projects and investments. With this amount in mind, you can chisel out your goals for the next month that are achievable within this amount.
That’s budgeting in a nutshell. As to why budgeting is important, its simple really. Budgeting is all about not taking any chances. When you create a budget, you know exactly what you will be doing and how you will do it. There won’t be this fear of the unknown, and you won’t be taking on projects that are not doable with your available income. Budgeting also reveals to you just how much you are spending and where you are spending it, which is great for developing a cost control plan. Typically, you would rather leverage budgeting and planning services than do this yourself. However, if money is tight than it’s better to know than to grope about in the dark.
Financial risk management is very important when running a business today. There are many kinds of financial risks, such as operational financial risks which we have already discussed in our publication titled “Unraveling the Secrets of Financial Controls and Risk Management”.
For the moment, let’s talk about financial risk in the sense of economic and market factors that can adversely affect the business’ financial stability and performance. Things like market volatility, economic fluctuations, internal liquidity issues and so forth come into the equation here.
These things may fluctuate seemingly incoherently, but there is always a pattern involved. It’s all a matter of probability, and preparing for the worst. Analyzing historical data and trends, makes it easy to predict how things will play out. But as always, things can and will go wrong, and this is where your prior calculated financial risk analysis makes it so you were ready for such a scenario and can promptly respond. Maybe you anticipated that one of your main products would drop in sales due to a new competitor in town, so you adjusted your production with that in mind and did not end up with excess inventory. Whatever the case may be, your financial data is a great asset to be used for risk assessment and control.
And with that, we conclude this short and sweet article on the basics of business finance management. Of course, many more topics comprise the subject. We will keep it short and digestible by just exploring the foundational basics every business management professional needs to be aware of.
has crafted a thorough guide on all of them.