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Five Strategies To Strengthen Your Company's Financial
By: Jeff Schein, Wed Nov 9th, 2005
Too many businesses wait until a crisis occurs before they start
to focus on improving their financial management. Often, by that
time, it can be too late. By setting aside an hour now to
evaluate the strengths and weaknesses of your company's
financial management activities and systems you can save a lot
of time and aggravation. It can also help increase your profits,
and at the end of the day that is what it is all about.
The following are five strategies that will help you start to
build a strong financial foundation and build value in your
1. Set up a financial control system
The first thing you need to start with is a control system so
that there is consistency in your process and procedures. A
control system is designed to prevent and detect errors in your
daily activities. For example, is there is a standard way of
processing your receivables, payables and inventory? If there
are no standard guidelines to follow, there is probably no
2. Have daily access to your account information
Make sure that you can access your account information every
day; it is invaluable to managing your cash effectively. With
most banks providing internet access at a reasonable cost, there
is no reason not to have instant access to account information.
3. Manage your cash components
Concentrate on managing your three main cash components:
accounts receivable, accounts payable and inventory.
Let's take a look at each component:
Make sure your credit and collection system is working
efficiently. Any excess investment in accounts receivable
increases the need to borrow more money to avoid a cash flow
deficit. That means that if you are carrying excess receivables
you are probably carrying excess debt and you have a direct cost
of having to carry that extra debt in interest payments. Even if
you finance the receivables through internal equity, there is
still an indirect cost; the opportunity cost of using that
equity elsewhere which could include expanding your inventory to
increase sales, reducing debt or earning interest on cash
Your accounts receivable collection period defines the
relationship with the cash flow process. Every month you should
be calculating your collection period and comparing with
previous periods and relating those results to industry
averages. Any material differences should be investigated.
Your credit policy can influence your cash flow and earnings.
Longer credit terms can increase sales and earnings, but any
decision to offer more liberal terms requires an estimate of the
trade-off between the cost of the larger investment in accounts
receivable and the bottom-line benefits of a higher sales
volume. Remember that increasing your credit terms will bring in
less credit worthy customers which can increase your bad debt
expense. You can, however, use price increases to offset more
liberal credit terms.
When you develop a receivable policy, consider the following:
.Check the financial health of customers before offering them
credit. Consider obtaining cash on the first order. .Do not make
your invoice terms too generous. .Charge interest to customers
who pay late. .Give discounts for early payment. .If you are
offering discounts, the terms should be attractive enough to
encourage customers to take the discount. This can also serve as
an early warning signal; if a customer doesn't take the
discount, or all of a sudden stops taking the discount, then you
may want to investigate further before extending credit as it
could be a sign of financial trouble. .Do not wait longer than
30 days for a late payment before you take action; you need to
minimize your company's exposure to bad credit. Put it into
dollar terms, if you have a $1,000 bad debt write-off and a 10%
profit margin, you need to generate an addition $10,000 in sales
just to make it back.
First, keep in mind that because of carrying costs such as
warehousing and insurance it is more expensive to carry
inventory than to carry accounts receivable. That is, reducing
an investment in inventory provides you a larger bottom-line
benefit than a comparable reduction in accounts receivable
because you are also reducing the carrying costs.
As with your receivables, it is important to complete a monthly
analysis of average inventory held in days. Compare to previous
months and industry averages and investigate any material
difference or change.
A periodic inventory count is a fundamental requirement; any
items that are overstocked should be investigated.
A sales forecast is vital, without it you lack the necessary
management information for inventory control.
Your target inventory investment should equal your normal
investment for core sales plus a built in safety stock (for
example if a re-order is delayed you want some extra stock on
hand) plus some amount for any anticipated growth in sales.
You can use the following equation to determine your economic
ordering quantity: SQRT (2SO/CP) where
SQRT = square root S = anticipated annual unit sales O = fixed
costs per order C = annual inventory carrying cost, as a % of a
products purchase price P = unit purchase price for product
Note that the above equation attempts to minimize inventory cost
by answering the question of how much and how often you should
order inventory. It is not perfect; the equation does not take
into account volume discounts and assumes that your demand is
constant. However it is a tool that can be used to help in your
decision making process.
The following are 10 questions you can use to review you
1.Do you have a sales forecast? Do you compare forecast to
actual sales and adjust the next forecast accordingly? 2.Do you
know which items account for 80% of your sales? These items
should be managed closely. 3.How fast can you get inventory?
4.How do you order inventory? 5.How much inventory do you order?
Do you order extra just to save a few extra cents? 6.Do you know
the cost of holding your inventory? 7.Do you rely on just one or
two suppliers? 8.How frequently is inventory analyzed to
determine obsolescence and makeup? 9.Do you have a policy of
determining what is obsolete inventory and how and when to get
rid of it? 10.Do you have an inventory reporting system to
provide the necessary tracking information?
Although you want to stretch your payables as long as possible,
much like you offer attractive discounts to your buyers you
should also take supplier discounts as often as possible if the
terms are attractive enough.
Make sure your payables are tracked on a regular basis - such as
weekly - and that your payment system runs smoothly.
As with receivables and inventory, complete a monthly analysis
of your accounts payable and compare to previous periods and
industry averages. Any material difference or change should be
Make sure vendors understand your company in case there is a
situation where you need to stretch your payables. You need a
plan to deal with those situations where you may have an
unexpected spike in your payables.
You should re-evaluate you vendors on a regular basis to make
sure you are getting the best value.
It is fundamental, you need to plan for growth and you need to
forecast for problems. You need to prepare a budget. Besides
completing a budget for expected sales, you should also complete
a budget for a disaster situation, like your sales are cut in
half. The benefit is very straight forward; it forces you to ask
yourself how you will be able to keep the company running in
such a situation. It will also point to areas where you may be
able to save money right away and free up cash flow. It's like
having a disaster plan; you only have to act on it when disaster
strikes, but it is much easier to concentrate when you do not
have a crisis at hand.
5. Develop a strong relationship with your Bank
Devote attention to building relationships with your bank.
Always keep them up to date on where your company stands. If you
hit a difficult patch it is much easier to get your bank on
board if they understand your business. Contrary to opinion,
banks do not necessarily jump ship as soon as you fall into
trouble. They are willing to work with small business through
tough times, and gaining their trust to do so is much easier the
more confidence they have in you and your company. They way to
accomplish this is to be transparent in your dealings and to
give them timely financial information.
Use you bank as a resource for cash management. There are
products available that can increase your cash flow, or
arrangements that can be put in place to increase your interest
returns. But you still need to make sure they are cost
About the author:
Jeff Schein is a CGA and offers consulting and advice in the
areas of business planning, business modeling, strategic
planning, business analysis and financial management for new
ventures and growing small businesses. Visit
www.companyworkshop.com or mailto:firstname.lastname@example.org