Is your accounting and finance function fit for purpose…….and how do you know?

In my previous blog I talked about The Business Performance Continuum and how at any point in time for business owners like us, our businesses exist on an axis between it being an absolute dream or a complete nightmare. And frighteningly, it can swing between those two points alarmingly quickly.

When you’re making money and the sales are rolling in you’ll be happy, relaxed and on top of the world, but as soon as things start to go wrong it can quickly unravel. Even to the point where the sales you made and the cash in your bank may even have been masking a horror that you weren’t aware of. 

Over my 30 year career running businesses and consulting with business owners I’d say that nine times out of ten when I’ve seen a business in distress and often collapse, it's coincident with a breakdown in its financial accounting. It’s for this reason that before we do anything with a client we make sure the financial component of that business is absolutely rock solid.

In my last blog I introduced our business diagnostic framework, The Rocket^© which is our tool for assessing the performance of every component of a business that we’re working with.

We use The Rocket^© to examine the capability of each key component of a business but it’s of course not accidental that the foundation of the framework is Finance and Cash Generation. No matter how bad any other component of a business is, it can be fixed. However, if you don’t have a robust finance component that underpins the business and that can be built on, you’re on borrowed time. As Warren Buffett has said “Numbers are the language of business.” If you don’t know the language how can you know how well you’re doing?

With a strong finance component in your business you can easily see how much profit you’re making and just as importantly how quickly it will turn to cash. This gives you vital insight into how much you can spend and what sort of runway you have before you get into trouble.

But what is a strong finance component?

Okay, so far so good. The problem is when I talk about a strong finance component that can mean different things to different people and also has different meanings in the context of different businesses. 

From experience I find that businesses do their accounting in all sorts of weird and wonderful ways. I've categorised them below in different levels of financial process capability and maturity which will give you an idea as to where you are. 

Alongside the different levels of maturity I've put what levels of turnover and/or complexity a particular level may be okay for and when it starts to become stressed and risky.

I’ve seen all of these different levels of maturity in businesses over the years but the sort of factors that mean you should strengthen your financial processes include:

1. Increased transaction volume,
2. Accelerating growth
3. The quality and financial literacy of your management
4. General complexity
5. Changes in payment terms
6. Larger contracts

Your Finance Component gives you feedback on the financial health and reserves of your business. As things accelerate you need a better dashboard, to tell you how fast you’re going, how much petrol is in the tank, whether you’re breaking the speed limit, what happens if you take your eye off the road etc. Look at it this way, if you’re driving an old Model T Ford at 25 miles an hour, you might get away with not needing much of a dashboard. If you have the same dashboard driving a Formula 1 car, the results could be lethal.

1. The brown paper bag

At its most basic level your financial processes might start off with a brown paper bag of receipts that you hand to your accountant at the end of the year. You as the owner, limit yourself to checking the bank daily. So long as there's cash in the bank you think you’re fine. That might be okay for a simple business of up to say £50k pa turnover. The the problem is you don’t truly know how much profit you’re making until 6 months after the year end. Remember cash and profit are not the same thing. (You can vote for that subject as a blog topic here and we'll let you know when we do it)

2. Spreadsheets

The next level is using spreadsheets as your main set of accounts. Again, that might be fine for your business. I've seen a £12m net asset property portfolio generating £500k of profit per year run off a spreadsheet. It wasn't great, but it was just about alright, because that business was so stable. For a more complex business however, particularly where credit is involved, a spreadsheet is not enough to control the business.

3. Accounting software

You might have double entry accounting software like Xero, Sage, Quickbooks etc. This is what I put in for the £12m property company which gave much better insight and control for that owner. 

However, just getting some software doesn’t mean those accounts are accurate. If you put garbage in you get garbage out.

At the very least you need some strong processes to make sure the relevant information gets to the bookkeeper/accountant in a timely fashion. We do that with a monthly work programme of key tasks and processes as to who needs to do what by when. (You can vote for that subject as a blog topic here and we'll let you know when we do it).

This is particularly helpful when you migrate it from a flat list or spreadsheet of tasks, to a task management system which automates reminders and emails a report of overdue tasks to the team on a weekly basis. Again, let us know if you'd like to know more about that on the blog and we’ll talk about some of the ways of doing that.

The other problem is that most business owners did not get into business to be an accountant. Tragic. I do feel sorry for them.

A lot of business owners don't understand their accounting software and reports and through a lack of financial literacy are denied the vital feedback and insight they need to run their business profitably and safely. I’ve had clients who had an accountant running Sage but because they didn’t understand the system, they kept their own spreadsheets. Far better to cut out the work and duplication and all work on the same system.

4. Quarterly/Monthly management accounts

At the next level you might get management accounts quarterly or monthly and really bear down on making sure those are accurate and robust and take action on the insights it gives you. That might be bearing down on less productive cost. It might be reviewing your margins by product or by customer. Now you’re talking. Financial mastery of your business is a key skill for any business and its owner.

5. Finance Director strategic oversight

When you’ve got that sorted you might need an FD to give you some strategic oversight and to turn historical information into forward facing predictions that you can use to start to plan towards a desired financial result. 

At this point you have a fully mature financial component. Now that is what we call a Firm Financial Foundation which gives a solid platform from which to build out and develop the rest of the business. When you make changes to your business and the other Rocket components, you'll understand the profit and cash impact and know if its something worth doing and when it can safely be done. This is why with every client we always begin by getting the finance and cash generation component of our business diagnostic ‘The Rocket’ nailed down first. 

In my next blog I’m going to introduce an infographic of a mature financial component of a business, so you can see what that looks like as best practice.

The perils of an immature financial component: A case study

So we've stepped through the different stages of financial maturity but what does that actually mean to a business? In my previous blog I talked about an Ecommerce client who scaled to £2m revenue in 18 months, however, his cashflow was so far ahead of profit that he couldn’t see the losses he was making. It ultimately meant he had to sell that business in a firesale. He did get £500k for the customer list, but that was needed to pay his trade creditors the next day which left him with only £5k in the bank as his reward for founding and running that business for several years. In addition the Cashflow Rollercoaster was a stressful ride!

The reason that business ended up getting away from him so quickly and ultimately the reason that we couldn’t save it when I got involved, was because he didn’t have a financial component that matched the needs of his business. He’d left his accounting in the hands of a tax advisor, which is very dangerous. The clue is in the name. That's the same for me the other way asking me to do complicated tax computations. I don't do tax, I control and build companies. It's a bit like asking your GP to do surgery on your brain. He didn’t have robust monthly management accounts. He saw the cash in the bank and felt secure but had no idea that was hiding losses. He was in a very precarious situation without knowing it. 

For a business of that scale and moving at that pace, his financial component was grossly out of kilter with the type of business he was operating. 

How to assess your financial situation.

Whatever industry your business operates in, it’s size today or your ambitions for what you want it to become in the future, the maturity of your business’s financial component needs to be appropriate. Some of the low maturity stages I outlined earlier might be perfectly fine right now, but the more complex your business is or if it starts to scale or if you want to prepare it to scale, then the maturity of the financial component in your business also needs to scale with it.

To assess whether you might need to take a step up the financial maturity ladder the first thing you can do today is complete our Free Profit and Cashflow scorecard. It only takes a few minutes to complete and will give you an indication of your businesses financial situation and if it would be prudent to increase the maturity of your financial component.

Once you’ve completed the scorecard we’ll also give you our Profit Calculator which is a tool to help you think about how you can start planning for the profit target you want. Of course, a big part of planning for a target profit number, is making sure you have the financial component maturity to tell you what you need to do in order to hit that target.

To your success.

Shaun