Financial Intelligence
Business leaders do not start their organization hoping to spend a lot of time doing accounting and finance, but rather doing what they do best, to fill an unmet need or provide a great new service. All leaders, however, need to have a high enough level of financial intelligence to know they are making the best possible decisions for their business. In addition, the more financial intelligence their employees have, the better the decisions of the organization will be as a whole.
Financial intelligence, although it is a recently defined term, has its roots back in 1954, when the management guru Peter Drucker wrote in his groundbreaking book, The Practice of Management, “[The worker] should know how his work relates to the work of the whole. He should know what he contributes to the enterprise…if he lacks information, he will lack both incentive and means to improve his performance… it is in the best interest of the organization that the worker has the information”. One piece of this information that Drucker was talking about is financial information. It is not enough that the employee has the information, but that the employee knows what it means and what to do with it.
Proponents of financial intelligence in organizations believe that if all employees understood financial information and how it is measured, then they would make decisions and take actions based upon this financial understanding to the benefit of the organization. If everyone knows the mission and goals of the organization and knows how the decisions they make help achieve these goals, the organization would be far better off.
Financial intelligence relates to the knowledge and skills of accounting and financial principles. It is not just theoretical knowledge, however, but requires practical real world application and experience. Overall financial intelligence requires understanding four key attributes:
- The Foundation: One must understand the basics of business measurement including the Income Statement, the Balance Sheet and the Cash Flow Statement. It also requires knowing the difference between cash and profit (there is a big difference), and why a balance sheet balances.
- The Art: Finance and accounting are both art and science. The two disciplines rely on estimates, assumptions, and rules to accomplish the end result. Financial intelligence ensures that one can identify where assumptions have been applied to the numbers and how applying different assumptions can lead to different conclusions. Understanding the assumptions behind a budget or forecast is critical to helping you make adjustments to your business when things don’t turn out the way you thought.
- Analysis: Financial intelligence means you know how to analyze the numbers to gain a deeper understanding of their meaning. This includes the ability to calculate surpluses, leverage, liquidity and various efficiency ratios and key indicators. When you understand the factors that make a program generate healthy surpluses, and how that factors into the overall success of your organization, you make better strategic decisions.
- The Big picture: Financial intelligence means you can understand your nonprofit business’s financial results in the context of the big picture: the overall economy, the competitive environment (other nonprofits and for-profit companies), regulations, and changing client needs.
Business leaders, managers, and employees in general who understand these principles and the effects of their decisions on the organization, will provide a competitive advantage to their organization.
5 Common Small Business Challenges
| In working with small growing entrepreneurial businesses, I have discovered several common financial related issues with which they struggle. When I first start working with these businesses, most if not all of these issues exist. All of them are critical to their success in managing and growing their businesses. The good news is that with time and focus they can be rectified. In no particular order, here are 5 that I see most:
1. Lack of Timely and Accurate Financial Statements
In today’s business environment, decisions are made at a fast pace. Information is readily available via the Internet, yet internal financial information to improve the decision-making process is sadly deficient. Most business decisions have financial implications, and without this basic financial information, it may be a shot in the dark. Many times the financial statements are put in a drawer and never reviewed because the information is too old (not timely), the business owner doesn’t believe the information is correct (not accurate) or the financial statements support the preparation of the income tax return, not running the business (not operational). They usually only become important when the business owner needs to meet with the bank. 2. No Cash Management As we all know from operating a business, cash is king! It is the common denominator for all businesses NO CASH = NO BUSINESS. Other than the current cash balance (most of the time determined by looking at the bank’s balance) most small businesses don’t manage their cash. Cash management includes understanding your business’s “operating cycle” (i.e. cash to cash cycle). To improve your “operating cycle” it is imperative you understand what it means, how to calculate it, and what influences it before you can improve it. Many times I will ask “what do you expect your cash balance to be in 6 months?” Most of the time they are fighting cash flow problems today and can’t think about the future past this week. Managing cash flow will provide a real sense of control over the business. 3. Poor Pricing Management
Setting the price of our products or services will drive revenues and just as importantly the “gross margin” for the business. Unfortunately, not enough time and attention is provided to this aspect of business. In working with small business owners, I find many have not revised their “pricing formulas” for some time, while others don’t really know their underlying costs to derive a sales price that provides profit. Many products are market driven because of competition, so it is imperative to know not only the direct costs but all costs necessary to produce a profit. Gross margin analysis by product line, products or customer is critical for small businesses. 4. Lack of Systems & Processes
Processes, whether documented or not, exist in all businesses. It is the way we perform the work necessary to produce our products or services. In most small businesses, the underlying processes to accomplish the work are rarely documented or reviewed as a whole (i.e. system). Developing efficient and effective systems and processes generally reduce costs and/or improve productivity. In businesses where there is a high turnover of people, documented processes are critical for training to ensure employees achieve higher productivity quicker. 5. Minding and Grinding Not Finding
Jerry Mills, founder and CEO of B2B CFO®, developed a simplistic organizational model for small businesses. He identified the 3 roles in small business as Finders, Minders and Grinders. Grinders represent the employees whose focus is about today. They generally work in the production side of the business. Most Finders start as Grinders. The Minders live in the past; their work is in the administrative, accounting, customer service or warranty departments. Minders are just as critical as Grinders to the success of the company and must be led. All Finders live in the future. They are the visionaries, innovators, and relationship builders. They are the passion and the drive for the business to grow and succeed. The entrepreneur is the Finder and must stay in the Finding role. Unfortunately, as businesses grow the Finder gets pulled into the company and works in Minding and Grinding activities. Without a change back to the Finding role, the entrepreneur/small business owner severely limits the business’s ability to grow. In working with small business clients, they almost always identify with this organizational model. As I mentioned at the beginning of this piece, these challenges for the small business owner can be corrected. Most of them are fundamental changes. As with most challenges and the related changes, awareness is the first step. . |
Do You Want to Make Your Annual Budget More Effective?
| Think S.W.O.T. and 10 Level Analysis |
It’s that time of year again! It’s time to start thinking about 2011. Are you one of those people who cringe at the thought of the annual business planning process? Love it or hate it, this process is a key ingredient for success. I’d like to suggest two tools that might make your annual planning process more effective:
S.W.O.T. Analysis All good annual plans start with some derivation of a S.W.O.T. Analysis. What is a S.W.O.T. analysis? It is simply a brainstorming and prioritizing of your company’s Strengths, Weaknesses, Opportunities, and Threats. Let’s take a look at these more closely: Strengths consist of all of the things your company does best. Some people call these your core competencies. These might be the things that give you a competitive advantage in your market or industry. For a consumer products company it might be how you manage your brands. For a manufacturer, it might be your outstanding quality or your efficient production process. For a service organization it might be your long established relationships. Whatever it is that your company does best, write it down. The goal of listing out your strengths is to identify your core competencies so that your plan for next year will include strategies on how to leverage your strengths to grow sales and market share. Weaknesses include all of the things you don’t do well. We all know what they are. It may be an antiquated ERP system. It may be a manager in over his/her head. It may be persistent quality issues. It may be lack of robust processes. It may be untimely and inaccurate financial statements. Other common weaknesses include poor customer service, out of control spending, poor vendor quality, poor internal communication, etc. The goal of listing out your weaknesses is to identify the behaviors and events that inhibit your firm’s success so that your plan for next year will include strategies to eliminate or reduce these weaknesses in order to improve the effectiveness and results of your business. Opportunities include all of the changes that you foresee taking place in your market or industry that will result in potential new business for your company. These could be internally generated opportunities (like new products, or new technologies) or externally generated opportunities (like new markets for existing products, or new customers). The point of identifying opportunities is to hone in on where your firm has growth potential and thereby identify areas of the business to dedicate resources in order to capitalize on that potential growth. This could mean hiring more people, or investing in capital equipment, or investing in research and development. Threats relate to all of those things, internal and external, that can hinder your success or disrupt your business model. Examples of threats could include things like a potential work stoppage if your union contract expires next year, new competitors entering your market, new disruptive technology introduced by a competitor (like the iPad or iPhone), changes in governmental regulations that could increase operating costs (like environmental or tax law impacts), or expected price increases for raw materials (like oil or steel). The goal of identifying threats is to make sure your plan for next year is aware of these potential threats and you’ve included measures to minimize the negative impact these things could have on your business and strategic direction. So, before you “crunch the numbers”, make sure you go through your S.W.O.T. Analysis. Going through this thought process will make your numbers more meaningful and will dramatically increase your chances of success next year. Let’s assume now that you’ve done your SWOT Analysis and crunched your numbers and have in front of you a monthly Income Statement, Balance Sheet, and Cash Flow projection for 2011. Congratulations! You are now 2/3 of the way completed. You may be asking yourself, “Why am I not done? I’ve done the strategic planning and crunched the numbers. What else is there?” If you’ve missed something in your S.W.O.T. or other changes occur in the marketplace that you could not have possibly seen at the time of your annual budget, I’d like to suggest that you also do an analysis that gives you a road map to change your plan on the fly. That analysis is called a 10 Level. 10 Level Analysis is a tool that can be used with the annual budget to identify adjustments that need to take place if your sales volumes differ significantly from plan. This analysis looks like your budgeted annual income statement with 11 columns. The sixth column contains your budgeted numbers for the year. The five columns to the left of the budget column reflect your annual Income Statement at volume levels below budget in 10% increments (-10%, -20%, -30%, -40% and -50%). In similar fashion, the five columns to the right of the budget column are your annual Income Statement at volumes higher than budget in 10% increments (+10%, +20%, +30%, +40%, +50%). It is extremely important to point out that this is not merely a mathematical exercise. The key to this tool is to identify your required adjustments (both up and down) to variable expenses for each 10% increment or decrement to sales. That means quantifying changes to staffing and spending, if applicable, for each 10% change in volume. In addition, if you are so fortunate to be in a situation next year where volumes are trending significantly higher than budget (in the +40% to +50% range), then you may also need to identify at what increments you will need to invest in capital equipment as those volumes may exceed your current open capacity. The end result of this 10 Level Analysis is that you have an action plan and road map for revisions to your annual plan when you have significant changes in your volume assumptions. You know what to do with staffing, you know what to do with variable spending, and you know what to do with equipment and capacity for each 10% change to your budgeted annual volumes. To summarize:
So, if you want to make your annual budget more meaningful, I’ve got two thoughts – S.W.O.T. and 10 Level. Good Luck! |
The Wall Street Journal featured B2B CFO® as experts in cash flow management. 
