Strategic Finance – What Gets Measured, Gets Managed; What Gets Managed Gets Done!
WHAT YOU CAN MEASURE, GETS MANAGED; WHAT GETS MANAGED, GETS DONE!
Strategic Finance – two words which look unusual together! Strategy might be perceived as referring to ‘pies in the sky’ and Finance…well… boring!
by Alan Fahey
Take a step back for a minute and consider this – what one thing plays an integral part in your daily life and which can have a hugely significant impact on your life, your relationships and the amount of money you have in your pocket? Your business! With that in mind, would it not be fair to suggest that you should devote some time to planning what direction your business takes to ensure it is robust and viable to deliver the optimum return for you … i.e. Strategic Financial Planning!
Let’s start with the basics. Why does anybody go through the trouble and, sometimes, pain, of setting up a business? In other words, what is the purpose of being in business? Our assumption is that, at the end of the day, there is one primary reason – to make money!
And yet many entrepreneurs, regardless of how well they know the business they are in, actually have little understanding of the underlying financial principles of business survival….
What are the 7 Things every Business Owner & CEO should know?
1. What are your most profitable products?
2. Who are your most profitable customers?
3. What are the key cost drivers in your business?
4. What are the productivity metrics and drivers of your business?
5. What are the cash flow dynamics of your business?
6. What are the critical success factors for your business?
7. What are the key performance indicators for your business?
And when you know these, it’s just as important to understand how you can use the information gleaned from them to manage your business more profitably.
Business is about making money. To do this, it must simultaneously increase three things:
I. Net profit
II. Cash flow, and
III. Return on investment (ROI)
Net Profit is what remains after you deduct all the expenses you incur running your business from the revenue you generate from sales to your customers. It is critically important to understand that net profit is ‘what’s left over’ – it’s the bottom line. As the manager of your business it’s your role and responsibility to influence all those things or activities which ultimately affect revenues and expenses so as to make sure this bottom line figure represents the best return for all the effort you put into running the business.
All costs and revenues are ultimately driven by two variables – products or services sold and customers. Given this fact, it should be obvious that you need to know which of your products or services return the highest profit and which of your customers are the most profitable to deal with. If we equip ourselves to understand what is really happening in our business, we can banish the curse of (ir) rational reason. You can increase profit in one or more of these ways:
i. Increase sales revenue by increasing price and/or volume.
ii. Keep variable costs at least equal to or below the rate of increase in sales revenue.
iii. Achieve greater productivity from the resources which are financed by overheads.
Proper planning allows you to work through each potential scenario and reduce business and financial risk. The key is to understand the likely outcomes of each option or strategy chosen. Ultimately, the success of a business is dependent on its business model and good business models are based on a Valuable Formula….
« What products or services you sell
« Who buys them
« Why they buy them
« How you make a profit out of the transaction.
Now that you’ve looked at improving profit, the business needs to convert this into cash. Cash Flow is a concept that can seem confusing, but an understanding of how it works is critical to business survival. Cash flow is an essential factor in the on-going health of a business. It consists of cash Inflows and Outflows.
Over the longer term, a business cannot grow faster than its cash flow allows
It is important to understand the essential difference between profit and cash flow. A business can be making profits yet have a negative cash flow position – caused by large fixed asset purchases or covering large debt repayments. The best way to ensure that Cash Flow remains positive, timely and available is to have a Cash Flow plan/ forecast.
Return on Investment (ROI)
The last element of the ‘three legged stool’ required to make money is Return on Investment (ROI). ROI is the net profit return you receive expressed as a percentage of the assets you have tied up in the business. It is another of the recognised profitability ratios that anyone interested in buying or investing in your business would take into consideration and so should you.
When looking at ROI, it’s important to remember that there is no point in increasing the assets you have under your control at a faster rate than you increase your net profit as this will drain your cash reserves (if any). As a manager you need to carefully manage the assets that produce your net profit and cash such as inventory and receivables.
Once you have reviewed and evaluated all of the above and compiled all of them into a strategic business plan, this should then lead you to establishing a thorough understanding of the goals and objectives required in each area of the business. With these in place, you are in a position to determine which processes will be the critical ones in achieving those goals. These are called the Critical Success Factors (CSF’s) – those things you absolutely must get right in order to achieve your goals.
Once your CSFs are known, you have to set up the procedures to achieve them and suitable Key Performance Indicators (KPI’s) to monitor whether they are being achieved. One of the biggest mistakes businesses make is establishing a set of KPIs that are not measurable or that measure the wrong thing. KPI’s are the tools that you can implement in your business to measure how a certain area of your business is performing and the success of operations. The key to establishing KPIs is that they are measurable and that they are relevant to achieving the goal/CSF.
As business managers, we need to keep reminding ourselves of this truism:
what you can measure, you can manage.
Regular analysis of KPI’s enable you to identify market fluctuations or changes early on, and allow you to be a step ahead of your competitors. As a result, they should be reported (and acted upon) on a timely basis. The implementation of an effective KPI system helps you align your short term performance to your long term business goals. It does this by showing whether or not you are on target for the longer term objectives. Importantly, you’ll also find that when you share KPIs with your team they will understand more clearly what you are trying to achieve in your business.
To summarise, when you’ve considered, evaluated, reviewed and implemented each of these 7 things, you have in effect created your own Management Control Plan for your business …. and guess what – looked at your business from a Strategic Financial perspective! In order to stay in control, this plan now needs to be measured and monitored on an ongoing basis so that you can build and protect your money, your life and your relationships.