Financial management, the key to success (Part 1)

By Peter Cox August 09, 2018 Industry news

The first in a series of articles on financial management to serve as a useful reference for you in the future.

I have spent nearly two thirds of my working life training, writing, speaking at conferences and consulting in this industry, both from the stores’ and suppliers’ perspectives.

In fact I was at one stage a Director of the Financial Management Research Centre (FMRC) in the University town of Armidale in NSW.

I am compiling a series of articles on financial management for this publication to serve as a useful reference for you in the future.

Financial management principles in hardware stores – unlike technology – do not change!

So, to start the series, why don’t we start at the worst possible ending?

What has motivated me to write this series of articles?

I have just read two books – HIH: The Inside Story of Australia’s biggest Corporate Collapse (written by Mark Whitfield) and Rich Kids (the story of One.Tel, by Paul Barry).

The similarities between why these two corporations failed are astonishing and they relate in some ways as to why hardware and trade stores can fail.

Over the years I have read numerous studies by academics on the failure rate of small and large businesses and it’s a consensus that up to 90% of these failures can be attributed to “poor management”.

 

WHAT IS POOR FINANCIAL MANAGEMENT?

But what actually constitutes poor management?

What is it that causes the hopes and aspirations of so many hardware store owners and managers to be dashed?

Across all retail business sectors you will find the following very high on the list of major reasons for small business failures:

  • Undercapitalisation.
  • Poor inventory management.
  • Poor credit control.
  • Inadequate accounting and inadequate management information systems.
  • Cash flow crisis.
  • Poor control of GP margins, sales volume and expenses.
  • Excessive drawings, wages or dividends.
  • Excessive investment in Fixed Assets.
  • Unplanned financial structure.

The same sort of problems can arise in businesses of all sizes in this industry.

However, the sort of costly errors that a larger business can absorb may mean the demise of a smaller standalone operation with more limited resources.

 

WHY SMALL BUSINESSES FAIL

The main reasons for small business failures are briefly explained as follows:

Undercapitalisation – Because of the limited financial resources of their owners, many hardware stores are doomed almost before they start. They begin with extremely shaky capital foundations and before very long they stall without really having had a chance to succeed. You need a feasibility plan and a Profit & Loss budget linked with a Cash Flow Plan before committing a dollar towards opening the store.

Poor stock management – Owners and managers of hardware stores often fail to determine properly how much stock they should hold and what kind. They may hold too little of the right kind, and so miss out on sales. Or they may hold too much slow moving stock “problem lines” or even unsaleable stock “dogs”. In this case, scarce funds which may have more profitable uses elsewhere in the business are tied up unnecessarily, not to mention the additional costs of storing excess stock.

Poor credit control – In their rush to make more sales and build up good relations, many owners and managers are lax in controlling their debtor’s accounts and extend credit to generally any new trade customer and customers who are perennially late in paying their bills. This can force a store to become a slow payer itself and so damage its reputation with its suppliers. It could take just one large account going bad to sink a business.

Poor accounting and inadequate management information systems – “If only I had known about the situation earlier!” is an all too common statement from failed owners and managers. Inadequate record keeping, bank reconciliations and review of financial statements are not done on a timely basis, thus the business is flying blind.

While many owners and managers are loath to do and or review the bookwork to keep a finger on the pulse of the store, they wouldn’t dream of driving a car without a speedometer or a fuel gauge.

Cash flow crisis – An increase in sales usually means greater stock holdings and more credit granted. If the store grows very rapidly, the resulting increase in stock and debtor levels can cause a cash crisis known as “overtrading”, that is to say growing at a rate faster than the cash resources will allow. Paradoxically, the result is the business may be more profitable but, if there are no additional funds that can be invested, the growing business could go into bankruptcy.

Poor control of GP Margin, sales volume and expenses – At the heart of any store’s activity is the fundamental relationship between expenses, sales volume and Gross Profit Margin. Expenses can grow to the point that they cannot be covered by the profit margin on sales, margins are often squeezed by trying to compete on price alone and often there is no idea of the breakeven level of sales at which costs are covered and the store makes a profit.

Excessive drawings or wages and dividends – A common mistake made by people who have gone into business for themselves is to draw far too much from the business by way of wages, entertainment expenses, fancy cars and even boats and other extravagances. Some just see cash coming in and want all the perks of being successful in business without having earned them. Better by far to plough profits back in for a rainy day!

Excessive investment in fixed assets – Another pitfall for newcomers to small business is to initially invest too much in vehicles, equipment, shelving, premises and facilities. The problem with investing too much in fixed assets causes cash outflows to increase and this means the store has to sell even more to cover these additional costs.

Unplanned financial structure – This is where owners and managers don’t plan their funding requirements well in advance. If extra funds are available, they tend to be in the wrong form. The basic financing mistake is to use short term funds for long term purposes or borrowing too much money (“overgearing”). Remember, every extra dollar borrowed means less control over your destiny.

In the next article in the series I will explore the objectives of good financial management. 

 

 


Peter Cox is a senior consultant for Macquarie Advisory Partnership based in Sydney. He has over a decade of experience training and consulting in the retail hardware industry. He conducts key-note addresses, and management and sales workshops, which are aimed at improving profitability and liquidity in one of Australasia’s most competitive retail  environments. Phone 0061 438 712 200 or visit www.petermcox.com.au

You can read all of Peter Cox’s Money Matters articles from 2014 on our website by typing the following URL into your browser: www.hardwarejournal.co.nz/categories/money-matters/

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