Three Steps to Being a Finance Star
Feeling intimidated is an emotion most people avoid. Some of us like the feeling of an adrenalin rush more than some; some prefer to relax by the pool. But I don’t know anyone who is fond of feeling intimated.
Remember when in school you didn’t know the answer to the teacher’s question and you prayed you would not be asked. Sure as anything the teacher would pick you to answer in front of the whole class – 25 pairs of mocking eyes. Perhaps it was the school bully, your first boss, or an opponent you faced in sports who seemed to be three years older and bigger than everyone else on the team.
Intimidation can also happen in business – perhaps in a hostile meeting between two competitors working for different companies or between people within the same company but with completing interests.
Are you intimidated by a series of words and numbers on a piece of paper? I am not talking about a break-up letter or termination contract (ironically the same thing). This is the story about a gentleman I have worked with for a number of years and about one of our first meetings together. As always, the names have been change to protect the innocent.
Malcolm is like the majority of business owners I have worked with. He has a comfortable presence about him (he is, of course, the boss); he has a high degree of knowledge and intelligence about his business; he also possesses a high level of general intelligence and/or street smarts. As I sit down with Malcolm, I see a different side of him; he is uncomfortable, uncertain and intimidated by what I have put in front of him…and no it wasn’t a snake.
What I presented to him was the financials for his business over the last 12 months. When I have the first financial review session with a client, I always provide the client with a full analysis of their last 12 months of business. This review focuses on what is done well and what needs improvement pointing out areas that can be capitalised on and risks that need to be mitigated. The reason I provide a 12-month review is that it is probable that the business owner has not been exposed to this level of detail before and I use this opportunity as a teaching tool for the owner to identify their business goals.
Malcolm’s body language and facial movements indicated that he is intimidated by what I have put in front of him. Like most business owners, he is not used to being put on the back foot. The problem is that I have just provided him with seven pages of data which have 12 columns (one for each month) and approximately 25 lines of data on each page which equates to approximately 300 pieces (I had to think about this, and, no, I didn’t use a calculator) of data.
So the question you may ask is why on earth would I want to bombard him with all this information? Fair question. Financial reports are necessary to provide a full picture. Yes, there are reports where you can provide Key Performance Indicators (KPI’s) which is a summary of performance. However, to “play with the big kids”, you need to understand the full financials of your business.
As logic would tell you, a particular skill has start somewhere and you will progress with your knowledge and become more proficient the more often you do it. The same is true about understanding financial information.
When speaking with Malcolm, I need to put his mind at ease so that he doesn’t just see a bunch of numbers and words but something actionable and practical. This should be the same with your financial understanding – don’t put pressure on yourself to understand everything the first time around.
I shared with him about listening to a Tony Robbins CD (that’s how long ago it was) many years ago which I think is very relevant for learning and applying financial information.
Tony Robbins was speaking to a Grand Master of taekwondo and he wanted to understand why most people never reach black belt in taekwondo. The Grand Master said that there are six key movements you have to master and if you can do them proficiently then you will become a black belt…simple as that, plus some practice.
Tony asked why don’t more people reach black belt if it is that simple? The Grand Master explained that people want to learn something new rather than mastering the basics. This is the exact same reason I believe most people don’t achieve mastery in understanding financial information. They may overcomplicate things (or things might be made overcomplicated for them by an advisor) and they are unsure about on what areas they need to focus their time to achieve the maximum success by understanding the basics.
So I started the process of turning Malcolm into a Grand Master of financials. Fortunately for him (and for you) I believe there are only three steps to achieving financial success.
1. Revenue – Sales and marketing
This might appear obvious but accountants can sometimes forget that they are speaking to salespeople, not financial wizards. There are the odd exceptions where sales and marketing are not important (for example, a venture capital funded venture, such as Instagram, Whatsapp, etc.) but for small and medium-sized businesses, we need to sell and have enough willing clients to pay. Otherwise, we are defeated before we start.
I showed Malcolm the information that appears at the very top of a Profit and Loss report.
I will go into more detail in future posts about the specifics of what you need to monitor with revenue, but these are the key areas you need to monitor with revenue:
- Are you selling enough to breakeven let alone make a profit?
- What are you selling? It’s important to know what products/services are the biggest contributors to your revenue.
- Who are your buyers? Do you know your customers individually or as a business? Do you know anything about them or are they just walking in the door and out again after a sale and you know nothing about them?
- What are the trends in your revenue? Is there seasonality to your revenue (for example, retail pre-Christmas)? What is the general direction of the revenue of your business? Is it going up, down, or sideways?
- Where are you selling? Is there a particular location geographically which is doing better than others?
For Malcolm (and you) stage one black belt in financials is understanding your revenue.
2. Cost of Goods Sold
Cost of Goods Sold (COGS) is a fancy accountant’s way of saying, how much did it cost to make what you sell? I believe when you know what it costs exactly to sell your product, and then you can take control of your businesses success.
This section appears directly under your revenue on your Profit and Loss Report.
With COGS you need to make sure you can sell your offering for a high enough price to cover your COGS, your fixed overheads, and leave a profit. Generally, your fixed overheads are easy to calculate (rent, electricity, bank fees, etc.). However, what it costs to produce your offering isn’t always that easy.
If you know what it costs to produce your offering, then you can be smarter regarding the price you set to sell. Again, we will explore this in far great detail in future postings, but if you understand your costs, it will help you with the following:
- Negotiations. If a client is sensitive to price you can negotiate in a way that can give you greater chance of winning the job but at the same time still make a profit;
- Know when to walk away. Would you be willing to sell something for $2.00 if it costs you $2.20? There may be exceptions, but for most small and medium-sized businesses, the answer should always be no.
- Setting targets. All expenses in the business should be relatively consistent in nature and you can set an exact target to achieve revenue to reach your profit goals. (I am going to show you how to do this trick in the coming weeks.)
3. Working Capital – Debtors and Stock
Malcolm’s final stage to commence his journey of being a financial black belt was to deal with working capital.
The information is on the Balance Sheet in the Current Assets and Current Liabilities sections.
Working capital is primarily made up of the following areas:
- Trade Debtors/Accounts Receivable – clients who owes your business money
- Inventory/Stock – the goods your business has on hand which can also include raw materials and work-in-progress
- Trade Creditors – suppliers that need to be paid by your business
Naturally it is important to pay your suppliers when your debts are due so they can continue supplying products as required. However, I believe mastery of debtor and stock management is the third step to being a financial black belt.
Firstly, a sale is a complete liability until the cash is received from a buyer. Think about it. You pay your suppliers and your employees for what they have done to produce the product, and until the client pays for the product, you are financially in the hole. The quicker you get paid by your clients, the better. You need to understand debtor management (yes, you will learn this in the coming weeks too).
- On average, how long do you wait for a debtor to pay their account?
- Are there any large debtors that pose a risk to the business if they are slow in paying, or even worse, don’t pay?
- What ways can we give incentives to clients to pay quickly?
- Who is responsible for debtor management in your business? This is often the most important person in your business financially.
Lastly, stock management. You want to make sure your store or warehouse isn’t a museum for what you sell. Every dollar of stock you have on the shelves is one less dollar you have in your bank account. But at the same time, you want to make sure you’re carrying enough stock to satisfy client demands and growth. This is a challenging balance but one I would explore with Malcolm throughout his journey.
So, from the 300 pieces of information I gave Malcolm, he knows the three areas he had to focus on. I said to him frankly, “If your business does those three areas well, it can almost do everything else poorly and it will still do well. Strong revenue and effective management of COGS, debtors, and stock and it is almost impossible to fail.”
This was the start of Malcolm becoming a finance ninja, but just like taekwondo, it requires constant focus and discipline to achieve consistent success.
Malcolm was no longer intimidated.