‘The top 5 mistakes SME’s make that hurt their financial performance and how to avoid them’
Front view of tired man in eyeglasses looking at laptop. Concentrated bearded manager sitting at table and thinking. Overwork, working late concept
When it comes to running a business there are a lot of good lessons you can learn by making mistakes. But when it comes to mistakes that impact your bottom line, most of the time we wish we hadn’t of made them or ‘knew then what we know now’.
With this in mind here is our list of the top mistakes SME’s make that hurt their financial performance and how to avoid them, based on the experiences of a CFO who works exclusively with SME’s.
– Not doing proper Budgets and Financial Projections
All business owners have goals.
Most know they need a strategy to help them achieve those goals.
But not many take the time to develop a Financial Roadmap to achieving those goals.
A Budget is not just an exercise in recording how you think your business will perform. When done well it is an intentional roadmap to how your business is going to achieve financial success. Do we have enough money to get the business off the ground? What marketing you invest in and when, at what point can you put on that extra support staff, when should your business be breaking even? These are all important decisions that a Financial Budget will help you to make.
An annual monthly P&L and capital expenditure forecast is adequate for most SME’s. Ideally It should be built on the back of the businesses strategic plan with supporting Sales and Marketing Plans and Human Resources budgets informing key expenditure and a Cash Flow forecast to determine working capital required. For new businesses or businesses undergoing a strategic reboot it also a opportunity to set your Profit and Loss statement up in a way that allows you to effectively analyse your business. This looks like identifying key product or service categories and reporting Sales and Gross profits by these categories and grouping overheads into 5-6 key buckets that will help you more efficiently understand your costs each month.
– Forgoing or going cheap on Due Diligence when buying or merging with a business
We are sure we all either know or have heard a story about someone who bought a business and then later realised it was not worth anything close to the amount they paid for it. This one is a costly mistake that should happen far less than what it does.
Luckily the solution is simple. If you are looking to buy or merge with a business engage an expert to do Due Diligence on your target business. And not just any business expert or accountant, one with a lot of experience buying and selling businesses.
Unfortunately, a lot of SME’s or new business owners will forgo or look to save money on Due Diligence and it rarely works out well. Due Diligence may cost you tens of thousands of dollars but a bad business investment can cost hundreds of thousands or millions.
As advisors and owners we have been on both sides of a business sale and have a few free tips we can share. Firstly, watch out for Addbacks to profits from business sellers. A good rule is to pay on performance not potential. Secondly, even if you are not buying the balance sheet you should be analysing this. Often the balance sheet will give a better historical picture then a ‘normalised’ Profit & Loss. Finally, it shouldn’t just be about Financial Analysis but should include commercial Due Diligence. Commercial Due Diligence includes an assessment of operations, staff, Market risk and competition, customer and supplier relations and regulatory compliance.
– Poor Cash flow Management
So much has been written about the importance of cash flow that you would think that for most business owners this would be one of their top priorities and they would have a plan to address this. Whilst the first point may be true unfortunately a large amount of SME’s are still not proactive or effective in their cash flow management. And access to working capital is still one of the biggest growth challenges SME’s face.
Maximising sales and operational effectiveness when taken to the extreme can run counter to good cash flow management and this is an area where a lot of businesses fall down. A sale is not a sale until it is paid for and so good credit management with incentives for customers to pay on time should be part of your business plan.
Similar to this a good purchasing policy shouldn’t just be about ensuring you have enough to meet clients needs. Considering timing of when to buy and how much can make a big difference to your cash flow. Finally, good cash flow forecasting can be vital to a business’s longevity, particular in poor economic conditions such as what we currently face. A reliable cashflow forecast is built on industry, supplier and customer payment trends and has a minimum rolling 13-week projection referenced to a long-term budget and associated cash flow model.
It would also be remiss of us not mention the trouble a lot of businesses get in to by not allocating funds away to pay the ATO what they are owed. The ATO can be the easiest Vendor to rack up a debt with for most SME’s and ironically can also be the easiest to pay. The full proof way to managing this is to not treat things like GST, PAYG and Income Tax as your money and to put this aside in a separate bank account or Pay the ATO as and when money is received, profit is recorded or payroll is paid. Failing this though there are many other options to pay the ATO including generous payment plan terms. Whichever way you decide to pay the key is to build this into your cashflow forecasts and not keep delaying this and letting it accumulate as this usually just papers over a deeper problem in your business you are not addressing.
– Not properly analysing margins and pricing
Most SME’s we encounter appreciate the value in analysing their profit margins and getting their pricing right but unfortunately many don’t have the right systems and processes in place to calculate and analyse these accurately. Unfortunately, this results in businesses having incomplete information or inaccurate information which makes it much more difficult to make good decisions about the future strategy of the business.
As touched on previously being able to break up your reporting to analyse margins by category, market segment and/or region can be quite insightful for businesses as it allows them to clearly identify the areas of their business performing well and any that need improvement. Further drilling this down by customer and product are also essential in guiding pricing, ranging and customer retention decisions.
A common error for product businesses in analysing margin and setting prices is calculating the full cost of a product, which can include incoming freight costs and the cost of labour for manufacturers making a product. For service businesses they are prone to discounting their own labour cost on projects which artificially inflates product margins. The solution here is to have good information systems or programs that help you to tabulate and factor in these costs correctly and for these to be included in your financial reporting.
– Not taking the time to regularly review your financial performance
You can be getting the first 4 items on this list right and things can still come unstuck if you are not regularly reviewing how your business is performing. As the old adages goes ‘what gets measured gets managed’ and importantly the reverse is typically true that little will happen to the important parts of your business if their performance doesn’t get measured and reported on.
Some of things we setup for our clients include Regular (Daily or Weekly) Dashboard reporting on sales, margins and costs, Weekly Cashflow reporting sessions and Monthly/Quarterly Full Performance dashboards. However, the feedback we overwhelming receive back from our SME clients is that while this reporting is essential what they love the most is the 1-2 hours each month/quarter we spend reviewing and discussing the businesses performance, the factors impacting this and appropriate actions to take.
The important take-out here is that while strategy planning and projections are an important to guide a business, the roadmap is not the terrain and you must be regularly reflecting on performance and discussing what it means for your business and your direction moving forward.
Contrary to some popular thinking you don’t need to make a mistake to learn the lesson. It is the SME’s that don’t make these mistakes or learn from them quickly that are the ones that are high performing and long running!
Joseph Essey – Associate Partner – Small & Medium Business Advisory, Accounting and Financial Control
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