Telltale signs you cannot handle your company‚Äôs finances
Every entrepreneur needs finance skills. But not every entrepreneur has them, according to Neil Petch, Chairman at Virtugroup.
Most entrepreneurs will have bags of acumen and expertise in their chosen sector–if they did not they would not be there in the first place. But managing a start-up’s finances often proves to be one of those things that is learned the hard way.
To be clear: cash flow can be used to predict the success of a business in 83 per cent of cases. So what behaviours, tools and techniques can you use to help you move in the right direction?
Make finance a priority
If finance hasn’t been a focus area for your business in the early stages, you may want to take stock of your current position before you go much further. How you deal with your company’s finances can have far-reaching consequences beyond the obvious immediate monetary effects.
Having worked with numerous start-ups and young businesses, I’ve found some key ways to make sure that the finances get off to a solid start. There are certainly red flags to look out for, and this article will help you identify and act on them.
So what are those bad financial habits?
1. You have no financial forecasting in place:
Financial forecasting can seem like a luxury for a busy start-up with a lot on its plate. Balancing the books alone is a challenge for tight margins. But, put simply, this isn’t an area where small companies can afford to be indifferent.
A study published in Research Policy in 2015 showed that, while innovation-based firms are more likely to apply for external funding, they are actually less likely to receive it. And this isn’t just a passing phase. Though compounded by the last global financial crisis, it’s actually a structural problem rather than a cyclical one, relating to issues of perceived risk, asymmetries in information and the very context-specific nature of many innovative start-ups. According to the research, these structural factors result in 55 per cent of innovative companies struggling to secure financing from their first attempt and 30 per cent not securing finance from any source.
In this kind of economic climate you’ll need robust forecasting in place to help mitigate the challenges of financing your start-up. Rigorous forecasting will help you gain insight as to when you’re likely to need funding, allowing a more organised attempt to secure the funds you need for your business, while at the same time helping demonstrate you’re a business that can be trusted with capital.
This is not to say that forecasting is straightforward, especially not for a micro-firm (defined in the UAE as having a headcount of 20 employees or less, and turnover of less than AED 10 million). But if you adopt some sensible principles you should be able to make a go of it.
Being realistic and grounding your forecasting approach in as much real data as you can muster is a good starting point–whether that data is your own or gleaned from market sources or competitors. Being conservative on the revenue side is also probably wise. This way, any outperformance of your business relative to your forecast will be a positive surprise.
Finally, making your forecast as automated as possible, while also making any assumptions completely transparent and easy to adjust, will mean you are able to run it more often and it will have more credibility both inside and outside your business.
Using these principles to craft a reliable financial forecast will help you build out a roadmap that is truly useful to the growth of your business.
2. Your accounts receivable is not well organised:
An aggressive working capital management (WCM) policy generally results in higher profitability for your company. This may seem like a matter of diplomacy, but if you do not establish a position of strength when it comes to collecting payments, not only are you more likely to run into cash flow problems, you’re also sacrificing profitability.
If you are struggling with the idea that you deserve to be paid on time for the services of your business, and feel that you’ll be viewed as playing hardball if you stick to your payment deadlines, do not worry. Though there is some research evidence that companies who take longer to pay their creditors are more profitable, in my experience this isn’t an acceptable tactic when you’re running a business that wants to prosper. It’s a far more sensible option to ensure your creditors secure their own profitability by collecting on time. Try to establish a culture of reciprocation with creditors and debtors – where you pay on time and expect to be paid on time.
Accounts receivable systems are increasingly automated, with some even starting to incorporate self-learning AI. But the fact is that managing inbound payments requires time and effort. Having strong processes and accounting information systems in place is a sure-fire way to manage your incoming payments.
3. You do not pay your vendors on time:
This is a trap that young companies can fall into which is ultimately detrimental to their prospects. If you take the view that your creditors should cut you some slack because you’re a new business, you’re in the danger zone. Not paying vendors on time shows a lack of professionalism that will cause rapid and perhaps irreversible damage to your company.
For all the talk of ‘hybrid professionalism’–a new model of organisational professionalism which puts less emphasis on traditionally ‘professional’ behaviours–the link between professionalism and how well a company is managed actually remains very strong.
Many young companies, in trying to be as up-to-date as possible in their business practices, have embraced these new hybrid approaches, combining a more rigid, traditional view of professionalism with newer, more flexible outlooks. But even in these hybrid approaches professionalism remains a key attribute, which is often used to advertise a company and enhance its brand. And it is still possible, by setting up a system of mutually beneficial timely payments in your creditor/debtor network, to make professionalism a key asset to your business.
Another factor to consider is the reliance of young firms on credit to fund their businesses. Many studies have found that start-up companies rely disproportionately on bank financing and other credit-based capital sources to raise funds. The fact is that late payments are highly detrimental to such companies’ attempts to secure finance, and as a matter of principle should be avoided at all costs.
For a young company the benefits of making payments to your creditors on time far outweigh the benefits of dragging your heels. If you want to receive the best services and maintain good relationships with your suppliers, paying on time is, frankly, an essential part of running your business.
4. You get way too excited by profits:
Without question it’s exciting to see your company start to become profitable. Yet research studies have found that firms which take a slower, more cautious approach to expansion and internationalisation are much more likely to succeed. While internationalising may seem aeons away for a new start-up, the same principles apply to those first steps of expansion. A mentality of measured caution is needed when making decisions about expansion, or a start-up brimming with good intentions and excited optimism can quickly be dashed on the rocks.
There are a few behaviours that can increase risk for a start-up when it attempts to expand. For instance, one study of software start-ups found that a discrepancy between a company’s stated managerial strategy, compared with the approach it is actually taking, is one thing that is sure to undermine an attempt at growth.
This study noted that business strategies often acknowledge the need for a careful approach–and for developing a good understanding of the problem that their product or service is aiming to rectify. The difficulty emerges when this strategy is not put into practice. So a high level of discipline is required in sticking to your plan, even if the appeal of speeding things up may seem great.
Breaking bad habits
Financial management covers a lot of factors, with many considerations that will affect your business in different ways, from the reputation of your firm to your chances of success. And even though an aptitude for managing monetary resources may not be the main reason behind people starting their own company, it’s a critical necessity in success.
The habits mentioned above are hard to break. You may find yourself wondering whether it’s worth the effort when your new or young company is already presenting you with plenty of challenges. But if you can tackle the behaviours described here, you’ll quickly find you can turn your financial management into a great strength for your company.