It is not an easy task to run a business. A lot of businesses fail every day all over the world. Small businesses fail and we usually blame it on inexperienced owners. However, big businesses, with teams of accountants, also fail. All these businesses fail for different reasons. However, financial mismanagement is the leading cause of business closures.
In this blog, we will look at some ways in which companies have poorly managed their finances.
Cash Strapped
Alan was the owner of Smart Ventures. Smart Ventures was operating a franchised supermarket for two months. At the end of second month, the bank statement shocked Alan. Despite making a lot of sales, his company was out of cash and that could threaten his plans for the holiday season.
An assessment of their financial statements showed that the company was profitable. It also showed that the company made a lot of sales each month. However, cash was low.
The franchise agreement allowed Smart Ventures to pay for supplies after 30 days. However, Alan chose to pay them upfront. He also paid for utilities immediately he received a bill. Paying expenses when they occur seems noble. However, it is better to delay payment of expenses for a while. This is an accounting concept known as accrued expenses. A supplier, offering that payment term, accounts for accrued expenses in their finances.
Smart Ventures will have more cash if they use the accrued expenses concept. A cash flow simulation of their account reveals this.
Obese Assets
A company wins a big contract, and the owners buy new cars. Another company starts and opens a lot of branches. After a few years, both companies fold up.
Assets are resources that provide future benefits for a business. Income Generating Assets (IGA) are assets that generate income directly for the business. Non-Income Generating Assets (NIGA) are assets that do not generate income but act as support facilities for the business.
Every company should have more IGAs than NIGAs. However, the decision confuses many business owners. This is because the grading of an asset as an IGA or NIGA differs with the type of business. For example, a car is an IGA for a car rental company but a NIGA for a bank. Many companies rush to buy assets without taking a critical look at the impact of the asset on their finances.
On another hand, the ratio of IGA to NIGA can also be confusing. A store is a critical infrastructure for a restaurant food chain. However, having many branches may have adverse effects on the company finances. The same applies to the branches/ATM owned by a bank. The most profitable bank may not be the one with the biggest branch network.
Successful companies sweat their assets. They ensure that any asset they acquire will give them maximum returns.
Walking in the footsteps of Giants
Fortunately, we live in the information age. We have access to some good examples that we can learn from. Through the internet, we have access to the financial statements of publicly listed companies. They give us a glimpse into the operations of these companies. We can learn from their successes and pitfalls.
Business owners need to pay attention to the path chartered by established companies in their industry. Many actions we take may have already been tried or implemented by others. A little research will go a long way to save many companies from ruin.
Understanding Financial Ratios