They say the vast majority of people work for small and medium sized companies. No doubt because there are naturally more of them in number.
In my experience (over many years in financial management and control) The vast majority of Business owners, Managers do not fullt understand their company accounts and the implications therein. Why?
Well There are 2 main reasons. One they have not had the exposure to accounts and finance. Two they are usually Engineers, Salesmen, Other Professionals and their interest lie in those areas.
The average small/medium size company employs an Accountant or an Accountant/Bookkeeper. His job is essentially the day to day operations. He must ensure that invoices are raised on clients, that stock levels are adjusted as goods arrive from suppliers and leave to clients. Collect overdue accounts, vital to the Cash Flow. Ensure funds are paid in to the bank promptly. Keeping the bank as happy as possible.(you will probably neeed them at some stage). He may well handle the Admin duties also. Modern technology should enable some interim figures to be produced for management, hopefully monthly. Excellent but what happens to them and the content?
If the owner or manager does not fully understand the implications of figures he has in front of him, then he cannot make valid judgement and take appropriate decisions.
Everyone in business should have sufficient grounding in basic accounts and understand exactly what they see, for example in a Balance Sheet. What the Resources of the company are, where they come from and where and how they are Employed. THE RESOURCES OF A COMPANY ARE PROVIDED FROM THEIR LIABILITIES. THE EMPLOY OF THOSE RESOURCES ARE SHOWN IN THE ASSETS. Basic knowledge like this enables you to see more clearly what is happening.
We can split our Balance Sheet into two sectors.
- Fixed Assets (land, buildings, machinery, vehicles) These should always be financed from Capital, Reserves or Medium/ Long Term Funds (Liabilities). NEVER SHOULD THEY BE FUNDED FROM CURRENT ASSETS. If there were Capital resources remaining after funding the Fixed Assets, they would go towards financing CURRENT ASSETS.
- Current Assets (Stocks, Debtors,Bank, Cash) should be funded from Current Liabilities (Trade Creditors, Other Creditors, Bank). as you can see these Current items are the day to day operations. The part the Accountant will be managing.
Off Balance Sheet items or Contingent Liabilities. These are items as yet not entered in the accounts. They might be a client dispute over a large invoice, a potential law suit, any other item that could bring financial cost to the company. Companies that deal in Foreign Exchange will have items relating to Forward Purchase and/or Sale of Foreign Currencies. The above is a simple example of a Balance Sheet to avoid complications.
Lets look at the daily operations of a typical trading company. If your clients insist upon say 60 days credit to pay their invoices, then it becomes obvious that you need at least 60 days credit from your suppliers or sufficient funds in the bank to pay suppliers invoices as they become due. Needless to say if you can't pay the supplier, you don't get further delivery of goods perhaps, so no sales - you are out of business. Simple facts but they need careful thought and planning. to protect Cash Flow the life blood of the company. Better to try and have slightly better terms from your suppliers to create a leeway of security against late payments from cl;ients or insolvencies. If you sell to a market which is susceptible to insolvencies from time to time, you may well consider getting protection with Credit Insurance. this is a contract which cover you against insolvencies..
If you cannot arrange adequate terms between your suppliers and your clients you will have to consider some form of bank funding to cover the shortfall. This can be a strightforward Overdraft., Invoice Discounting or Factoring. There is of course a cost involved so your margins must be able to support these. All three facilities provide funds at the stage of delivery of goods and invoicing, so you get the funds up front. These funds are to compliment and complete your deficiency in short term resources. so should not be used for any other purpose than day to day operations.
If you have good products selling to decent markets and you get the above type details set up adequately - you're in business. Imagine you started up business without getting to grips with these elements ( many do). One reason why insolvencies are running higher and higher.
I would like to write a few more articles complimentary to this and ... it may be interesting to run up some "T" accounts to show the flow of money. Trading and Profit and Loss accounts would follow.
