Financial Management 101- The Pillars of Financial Management

Our guest post for weseethebusiness.com highlights the pillars of financial management.

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By Robert Band, CPA, Founder and Managing Member of CFO & Co.

Entrepreneurs building their companies must have pillars to support them at the top. Imagine that your company is a 5-story building with each department on its own floor and you, the CEO, at the top.  Take away pillars on any floor and it won’t just be lonely at the top.  It will be dangerous, too.   So let’s proceed to earthquake-proof your company, starting with the Finance floor and your financial management.

The pillars of financial management are:

  • Financial Reporting
  • Financial Analysis
  • Cash Management
  • Capital Planning and Raising
  • Internal Controls
  • Key Performance Metrics

Financial reporting is the pillar people most readily associate with Accounting.  It requires the accurate categorization of transactions into “accounts” (hence the term “Accounting”) and smart summarization of those accounts into well designed financial statements that insiders and outsiders can rely on to measure performance and health of the company.  What gets measured gets better and this is your “report card”.  It tells the story of your business in numbers, not words.  It enables you to make smart, informed decisions (which means taking less risk), get bank loans and vendor credit, predict capital needs, spot trends, and ultimately profit to the extent that you can sell your company.

Where financial statements tell what happened, financial analysis explains why it happened.  Analysis is a must-have pillar to unearth what lies beneath the financial statements.  Remember, the financial statements are at a summary level.  To really know what’s going on, Accounting must drill down to the data.  Let’s say gross margin is declining, a trend that must be addressed.  To learn why, Accounting must run a gross margin by product (or client) report to find the culprits.  A financial statement without financial analysis is like an MRI without the radiologist’s report.  No insight?  No action.

Cash management involves preserving cash during periods of losses and investing excess cash when it builds up.  It also involves speeding up cash receipts and stretching out cash payments.   More than anything it requires a clear understanding of all the things that affect cash flow.  Net income or loss is only the beginning of calculating cash flow.  But other sources and uses of cash must be forecast, such as how many days receivables take to collect and in how many days payables must be paid.  Investments in fixed assets like equipment and leasehold improvements and debt repayments consume cash while bank borrowings provide it.  Everything in business begins and ends with cash. Owners must be fluent in their understanding and management of cash flow.

Capital planning and raising capital is making sure there’s sufficient capital to execute the business plan.  Capital comes from equity contributed by the owner or outside investors, or it comes in the form of debt from lenders.  Debt is cheaper than equity but there are limits to how much lenders will fund.  So projecting cash flow and sizing capital needs is essential.  It will reveal how much debt the business can afford and if that’s not enough, how much equity it must have.  Raising capital is the solicitation of lenders and investors and requires a cogent business plan with income and cash flow projections and a compelling story about future growth.  Approaching capital sources requires knowing who to approach and how to talk their language to close them on your offering.

Internal controls are safeguards that protect you from theft (which is more common than you might think), control how cash is spent and make your financial statements accurate and reliable.  Keeping cash and inventory from walking out the door is usually high on owners’ priority lists.  Accounting must first understand how transactions are processed (who enters the data and approves transactions and how does the data flow inside the software(s).  Having the right belts and suspenders to control your structure without pulling them too tight and constricting the business requires a high level knowledge of controls and processes.

Key performance metrics are used to monitor the granular tasks that must be done in order for results to be achieved.  For example, in Finance, the inventory turnover rate shows how efficiently you’re moving the products you’re buying, the goal being to convert inventory to cash as soon as possible.  Another key metric is how gross margin is trending.  These metrics should be coalesced into dashboards that are personalized to each manager’s interests and responsibilities.

So how secure is your Finance floor and therefore, your superstructure?  Know that just because you’re a small business doesn’t mean that you must live without these pillars.  If you are lacking any of them or are not secure with their condition, reach out to experts to shore up your Finance floor.  Not only will you sleep better but also you’ll find that everything is easier, faster and better as a result.

– See more at: http://weseethebusiness.com/financial-management-101-pillars-financial-management/#sthash.yaxO8Z9r.dpuf

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