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Business Basics: The Finance Fundamentals you need to master for growth

How to use business management information to drive and measure growth

Small to Medium Enterprises are quite exposed to the changes in the external environment. In the earlier phases of their business life cycle and before maturity, SMEs fight for their survivals; some little mistakes and wrong decisions can result in devastating consequences on their going concern.

 

In this scenario, during the growth stage even if the managers are experiencing profits and increasing sales, significant threats stand around the corner: everything in this phase happens very fast and any organisational weakness and a weak business model could turn an extraordinary moment into a nightmare. It is essential that the SME chases profitable growth and generates cash and profit.

 

Some of the critical questions that owners and managers need to answer are:

Is the business profitable? Is the business generating cash? Is in the long term the financial structure (the gearin, the debt – equity mix)  right balanced?

In this context, a sound understanding of the financial statement plays a central role.

 

Cash is different from profit: a capex investment is a cash out item and does not represent a cost , conversely,  the depreciation is an non cash operational expense.

 

The need for financial understanding is critical and the business must be followed in at least three dimensions.

  1. The profit and loss to track the profitability. Is the business is able to generate profits? I.E. revenue covers costs.
  2. The financial statement to track the short term cash generation and to monitor the long term financial structure debt/equity mix.
  3. The business generate cash and the financial structure, the gearing,  is balanced.

The decision makers will face the need to precisely understand and answer to the previous questions, the abrupt change in the environment during the growing stage will add incertitude that must be assessed via financial report.

 

Effective ways to raise capital to fund business growth

There are some fundamental questions to answer before raising capital.

Do I need external finance? Do I need debt or equity finance? Do I need short or long term finance?

A general suggestion is to look for external financing when you are at the investor ready stage. Is the company business model efficient? By reworking on the actual term and condition with your customers/suppliers, you may reengineer the cash conversion cycle by reducing the financial needs and improving the DSO, DSI and DPO.  

 

Has the business considered to reinvest the retained earnings? By increasing the profitability and changing the dividends policies you may generate one of the best long -term funding: the auto financing.

 

To challenge the business model is a necessary step, because the chances to obtain external financing, in case the company presents weaknesses, is remote and unprofitable: the bank will apply higher interest rates and the venture capitalist will require harder term sheets and more control on the business.

 

The typical medium long term debt finance solution is a loan. The institution, a bank or a private FCA registered company, asks to repay the loan at fixed intervals against a predefined interest rate. This instrument is generally secured by collaterals such as the company’s assets and by covenants, operational constraint, such as limitation to distribute dividends before the repayment of the debt.

 

On the other side, long term financing could be provided by equity. Equity must not be repaid but is expensive, the company must give away a percentage of its control so that the term sheet and the conditions applied by the private equity could be quite unaffordable.

 

My personal suggestion is to consider a debt solution if the company is profitable, alternatively a debt/equity mix within a reasonable gearing. If the control is given away, the company should expect to lose some strategical drive and conflicts could rise from the new investor. The venture capital firm could interfere in the company management, they could impose a heavy and bureaucratic reporting.

 

It is very important that the SME recognises the timing of the underlying asset that needs to  be funded. The rule of thumb is that current asset must be covered by current and short term financing, while fix asset needs more medium and long term instruments.

 

The working capital could be typically covered by short term financing such as overdraft and factoring invoices. Fix asset is covered by long-term financial instruments.

 

How to avoid Overtrading

Overtrading often occurs when companies expand their own operations too aggressively with evident issues in term of working capital and financing. Hyper growth represents an opportunity and a threat in the SME business life cycle. This could be a unique opportunity to scale up in a very short time but the risk of over trading is high.

 

The momentum here is to transform overtrading in profitable growth, but what are the steps that could minimise the risks of overtrading and ride the unique opportunity to scale up quickly?

 

The first and basic need is to start this phase with a ready and consolidated business model. The company should have developed a consistent and coherent bottom up strategy. Is the market we are targeting in line with our strategy? Some trade off choices between profitability and term and conditions could be suitable: focus on less profitable customers in exchange of better payment terms.

 

Another tactical area to focus on is the cash conversion cycle. The company should have defined its Cash Conversion Cycle. For instance the company could choose to get on board customers that pay at 60 days instead of 90, even if less profitable.  Another component is to control the DSI, days on inventory. The company should operate as lean as possible. The goal is to minimise the lead-time from the receipt of the raw material to the finished good. The DPO is related to the suppliers’ payment and in general the SME tends to match it with the DSO. My suggestion is to apply the norm because it would be risky to annoy the suppliers and lose their loyalty.

 

In case you still face financial gap in the hyper growth phase, it is possible to  access to short term external financial instruments, such as factoring and overdraft. This is expensive, could reduce the operational freedom ie the need to balance the overdraft without notice and introduces some kind of accounting complexity.

 

Overtrading is risky but if the SME business model is strong and scalable, it is worth taking.  It represents a unique opportunity to quickly scale up organically the company.

 

Financial Decision Making

Any business decisions will directly / indirectly impact on the financial statements. For sake of simplicity let’s simulate the impact of a strategic and an operational choice that typically decision makers are asked to take.

 

What is the financial impact of a recurrent strategic decision such as a new investment in a new technology or in a new product line?  The effect of this decision will be in term of capex investments and financial returns. The cash out will impact in the financial statements and the returns will flow, hopefully, as additional profit in the P&L. What about product pricing increase? This will directly impact on company revenue, in their receivable and in the cash collection.

 

Operational day by day decisions such as changing the collection days, will impact immediately on the financial statement and in the generation of cash.

All the managers and the decision makers need to have a sound financial knowledge to evaluate the consequences and effects of their choices. Additionally the financial reporting and planning culture should be promoted to all levels and functions, instead of being considered a statutory  disclosing exercise, a waste of time keeping few qualified accountants busy.

 

The Importance of Business Plans

Determine the financial impact of the business decision is important, but not sufficient. The backward looking approach is fine but it becomes effective only if, complemented by forward looking actions. The importance of a control system lies in the fact that it is able to outline what did go wrong and to identify the future corrective actions to bridge the gap.

 

The growing stage is a complex phase in the company business life cycle, the environment is difficult to predict, there is limited visibility and high uncertainty of the future outcome. In this context there is a prolific school of thought, that recons no utility in the planning and budgeting process especially in erratic periods. Provided that there is low likelihood to hit the projections, better not to produce the budget and save the time and costs. In my opinion the more the environment is unstable the more budgeting and planning becomes key to success. In an unstable environment the company certainly needs to draw a possible scenario, a reference to follow, to evaluate the deviations of the actual results over the projection (backward view) and take actions to recover (forward view). The scenario comes from the company strategy and it will be used as an operational control system to manage the company consistently.

 

The likelihood to hit the financials  in term of profit and cash are low but the budget needs to be accurate not precise. It does not matter that you hit the sales figures and you generate profit  in the exact way you expected, but it needs to generate sales and profit in the direction to what was planned.

 

Without a planning process the company is basically blind and do not have any reference to compare. The company is unable to answer to its basic questions: Are we following the right path ? Are we executing and generating the right level of cash and profit?

 

More over the budget must be exploded into relevant and operational KPI’s and cascaded through out the organisation to grant an integrated and coordinated system of control.

 

All the organisation will look at the financials that are more relevant for their functions. Sales and Marketing will look at the Sales and customer satisfaction. Operation to headcount productivity and finance will keep an eye to cash collection and disbursements.

 

Advice for Planning and Funding a Growth Period

Do we have a growth strategy ? Is the growth aligned to our strategy and mission?

The company must follow a broad strategy, a SME simply has not enough resources, needs to be focused in some market / product. It could be that the strategy changes over time but this must be controlled , clearly communicated and cascaded thought out the organisation. At the strategic level the company should also determine different growth paths, such as should we grow organically or by external acquisitions? The latter is faster but expensive and very difficult to implement especially if there isn’t a consolidated strong business model.

 

Are we growth ready?

The company needs to have in place some kind of control system and some KPI’s to follow: A sound financial planning system enters in the equation in order to evaluate the profitable growth in term of profit and cash generation.

If the company is not hitting the target it needs to understand why and detect the most appropriate corrective actions. Maybe the overall strategy should be revised, may be some processes must be reengineered.

 

Do we have the right talents in place?

Developing a strategy is a question of people. You need the right mix of talent and skills playing the same team. On one side the visionaries able to set up the path and on the  other side individual able to implement , execute the strategy and reporting the results.

 

Mario d’Aragona

Mario is a seasoned finance executive, who serves as CFO for fire & security, food, energy and clean-tech global companies. He has turn-around experience and managed to re-finance growing businesses. Mario is the Managing Partner at TML Venture Ltd. and supports companies in finding tailor-made investment solutions. His industry focus is on renewable technology, energy and food companies.

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Finance

HOW FINANCIAL SERVICES CAN GET TO GRIPS WITH RISING SUPPLY CHAIN RISK

FINANCIAL SERVICES

By Alex Saric, smart procurement expert, Ivalua

 

UK businesses have never been more dependent on their suppliers to help them deliver goods and services to their customers. Be it retail, manufacturing or financial services, suppliers have a vital role to play when it comes to innovation and meeting customer expectations. However, as supply chains become increasingly global, businesses are potentially exposing themselves to more risk than ever before.

This is especially true in financial services. Whether it’s the impact of geopolitical events like Brexit or global tariff wars, supply shortages, security or the businesses impact on the environment, an organisation’s failure to identify and mitigate risk could see millions wiped off its share price, and its corporate reputation left in tatters. Risk can present itself anywhere and at any time, so financial services firms must be ready to address it. However, many simply don’t have the ability to evaluate suppliers for risk factors, leaving them wide open to business operations being hindered, or being slapped with financial penalties.

 

More suppliers, increasing risk

One reason why financial services firms aren’t able to evaluate suppliers is the breadth and scale of today’s supply chains. For example, French oil company Total said in in a recent human rights briefing paper that they work with over 150,000 direct suppliers worldwide. This is just one example of how large and varied the roster of partners has become. Research from Ivalua has found that financial services businesses on average are working with around 3,600 suppliers annually, which is evenly split between UK-based and international partners. That number is expected to rise, with 60% expecting the number of suppliers they work with to rise.

The expanding nature of suppliers is only going to expose financial services firms to more potential risk than ever before, yet 78% say they face challenges gaining complete visibility into suppliers and their activities.

A lack of supplier visibility leaves businesses unable to identify and mitigate against supply chain risk. In fact, almost three-quarters (73%) of financial services firms have experienced some type of risk during the last 12 months. These include; supplier failure (43%), environmental impact, such as pollution or waste (35%) and supply shortages (45%). Supply shortages can be among the most damaging to a business, as seen by both the KFC chicken shortage which closed stores, and the summer 2018 CO2 shortage which caused companies such as Heineken and Coca-Cola to pause production, impacting supply across Europe during the World Cup.

 

Businesses unprepared for the worst

One way financial services firms can better prepare for risk is to ensure they know what to plan for to reduce the impact. However, whilst some say they have a contingency plan in place to deal with risk, many of them are unprepared. Financial services firms admitted to not having comprehensive and deployed contingency plans in place to prepare the supply chain for risk such as; natural disasters (68%), supply shortages (67%), geopolitical changes (65%), environmental impact (63%), supplier failure (62%) and modern slavery (50%).

In order to effectively prepare for these types of risks, it’s vital that financial services businesses fully understand their suppliers, their business environment, global variations in regulations, geopolitics, and a host of other factors. But for many, there are multiple challenges when it comes to gaining this understanding. A prevailing factor is an inability to gain visibility into all suppliers and activity because supplier management data is stored in multiple locations and formats, making insights difficult to access. This leaves teams unable to review supplier activity and assess compliance.

 

Making supplier management smarter

It’s imperative that financial services businesses are able to respond or prepare for supply chain risk. Clearly, much more needs to be done to ensure they have complete visibility of suppliers, especially in an era where regulators can levy heavy fines for GDPR breaches and scandals spread in minutes over social media. These types of risks can be reduced in the future if procurement teams have a 360-degree view of suppliers which will help with contingency planning and risk management.

For example, in the instance of supply shortages, plans could be put in place that identify alternative suppliers to ensure any shortages do not impact end users. This type of supplier collaboration is paramount when it comes to managing and mitigating against supplier shortages. When it comes to regulations, financial services firms can’t allow a lack of visibility to limit their ability to ensure all suppliers are compliant.

To do this, teams must take a smarter approach to procurement that gives complete visibility into suppliers throughout the supply chain. This will allow financial services firms to identify and plan for risk, reducing the potential damage, and ensuring they are working with and awarding business to low-risk suppliers. Supply chain risk is rapidly becoming an overarching concern for financial services firms, but by providing the ability to assess suppliers, they will have all the insights they need to mitigate the impact on business operations.

 

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Finance

ISO 20022 – THE BEDROCK FOR PAYMENTS TRANSFORMATION

PAYMENTS

Lauren Jones, Global Payments Ambassador, Icon Solutions

 

The financial services industry has seen ISO 20022 grow firmly over the last 15 years. What was then a small pocket of countries tackling migration has now become widespread adoption for domestic and international payments.

And with momentum building, it is clear that IS0 20022 is playing a foundational role for banks in the transformation of their infrastructures, with the rich messaging format delivering business benefits and enabling enhanced customer propositions.

 

PAYMENTS

Lauren Jones

The time is now for ISO 20022

European initiatives, such as SEPA, were the first to drive usage, but have since catalysed a network effect in other countries. Recent examples driving adoption include the New Payments Platform in Australia and the Bank of England’s Real-Time Gross Settlement (RTGS) service doing the same in the UK.

Despite the timeline delay, the SWIFT migration to ISO 20022 for cross-border payments will drive further adoption and it is clear to see why. As the world becomes more connected, having a globally interoperable standard is attractive. ISO 20022 allows banks to have a consistent experience across geographies and provides a low-risk approach to modernisation.

In the US things are moving as well. With the country’s most important payments market infrastructures, the Fedwire and The Clearing House Interbank RTP system, migrating their High Value Payment (HVP) systems almost concurrently, widespread ISO 20022 has reached a tipping point.

For US banks this means it is important to understand that ISO 2022 is no longer happening “somewhere else”. Banks dealing with the modernisation of infrastructure need to decide what will become the bedrock of their transformation efforts. ISO 20022 seems to be the only sensible choice.

 

ISO 20022 in practice

While banks in the US and across the world grapple with ISO 20022, it is crucial that they engage internal and external stakeholders early on in their journey to define their strategy. Resources should also be pulled from all areas of a bank, including technology, operations, AML, product and sales.

Implementation is not just a technical issue. Governance, sequencing and coordinating activities are all vital for success.  Banks need to lay a foundation where legacy systems are ringfenced, but it is equally important for them to understand how to move rich data through or around legacy infrastructure as early as possible.

Deciding what to do with legacy systems is a challenge for many financial institutions. Therefore it can be useful to deploy mapping or translation services in the early stages of adoption. In fact, many market infrastructure ISO 20022 programs include a phased approach where there is a like-for-like phase (where no new functionality is used), allowing adopters to become familiar with the new standard.

This is often followed by multi-year adoption of new functionality and gradual decommissioning of legacy formats.  However, mapping should not be viewed as a longer-term solution. To harness the full value of ISO 20022, supporting the standardisation natively allows banks to build from the ground up. This creates a modern data model where both internal efficiency and external value can be realised.

 

ISO 20022 is the way to deliver added value

One of the major drivers for ISO 20022 adoption is to remain competitive. By implementing a common standard banks can have a platform to innovate at pace and with lower costs.

Many banks now see ISO 20022 as a critical foundational element to deliver value to their corporate clients. But the benefits of ISO 20022 are not solely external. Increasingly, APIs are being used to support both deep integration within the bank and with a broad spectrum of fintech partners. ISO 20022 allows the capability of having a single data model across various computer languages and therefore across multiple use cases.

With a shift towards data-driven architecture, ISO 20022 allows banks to generate greater amounts of standardised data to provide targeted insight. The move to ISO 20022 will therefore be of paramount importance for banks to take advantage of richer, standardised data sets. With more payment volumes set to adopt ISO 20022 by 2025, the discussion is moving on from the standard simply serving transactional needs to the data that can be extracted from these transactions.

 

Prioritising payments transformation

In other words, over the next few years we will see payments being refocused from a commoditised proposition to a strategic, value-adding one. Yet being “data-aware” is not good enough. Banks need to be powered by that data. As cutting costs is no longer enough to sustain banks, they must use payments data to deliver more appealing propositions and revenue-boosting, value-added services.

As the adoption of ISO 20022 remains fragmented in the US for the time being, many banks will continue to question how best to take advantage of the standard. However, it should be evident that ISO 20022 is coming and the time to prepare is now.

 

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