The importance of effective financial monitoring 10/06/2010

Take control or take a risk

In a recent article, I suggested that having an effective management team is key to weathering the current economic storm.  That team will, almost certainly, involve a selection  of individuals who, collectively, are well balanced, in terms of their specific abilities.

Underpinning the management team, there must be suitable systems in place to ensure that they are being provided with reliable information upon which to make appropriate decisions pertinent to the circumstances they are facing. Appropriate financial systems are the foundation for effective management.

The lack of regular management accounts is a classic early warning sign. Without meaningful, up to date and accurate information, management decisions are based on good luck rather than good judgement. There will inevitably be a greater propensity on the part of management to either make no decision at all (because they are not aware that remedial action needs to be taken) or make the wrong decisions which might exacerbate the difficulties the business is facing.

Too frequently,  I have encountered businesses in distressed situations where the projected cash forecast has not been prepared because management is waiting to finalise its operating budget.  Of course, that has not been finalised because management is also waiting on getting last month’s or the previous quarter’s results. The impact being that management may have an idea as to where they want to go but have no real idea of how they are going to get there.

It should go without saying that in today’s business world,  with the plethora of modern IT systems and accounting packages available, no business should be without regular accounts to allow management to monitor the performance of the business. Depending on the type of business, some form of management accounts should be available on a monthly basis.  For some, even more frequently than that. And, of course, the more critical the financial position of the business, the greater the need for even more frequent management reports.

Some management teams may consider that their business is too small to justify a system for budgeting;  but budgeting is not some dark art or akin to astrophysics. Budgeting can be as simple or as sophisticated as you want to make it;  all it really means is that the owner/management documents their plans for the business. This should be done in terms of both future expenditure and operational activity. It is only by doing so that they can measure how well their business is performing.

It seems obvious that if management is not really sure what something has cost to produce,  then pricing it at a level that will generate a profit is a matter of guesswork. Sadly, businesses can fail for the simple reason that some of its products or services make profits while others make losses.  The absence of a costing system means that management does not know which is which. So, not only is some form of budgeting system fairly fundamental but also a costing system should be utilised by management if they are to avoid the pitfalls that are awaiting the ill-prepared.  

Running a business can be compared to other things in life where, if you are ill-equipped,  you may, with a bit of luck, still get round the golf course or off the mountain but not nearly as well as you might have done if you had the right equipment.  

The afore-mentioned basic financial systems can be developed to incorporate monitoring stock control and credit control. The absence of effective stock control risks too much cash being tied up in stock or the risk of profits being overstated when old or obsolete stock has not been identified and written down to its real value.

Suitable credit control systems will minimise the risk of losses through bad debts. In the current climate, where credit is increasingly difficult to obtain,  cash flow is so important. Effective credit control will have a significant impact on the business’s borrowing requirements and cash flow – the life blood of the business.

Ewen Alexander is the partner in charge of business recovery and insolvency with Ritson-Smith.