FINANCIAL MANAGEMENT, THE KEY TO SUCCESS (PART 2)

By Peter Cox September 17, 2018 Money Matters

Last time we reviewed the reasons why a store can fail and you would have quickly seen a common thread: they all centre on cash flow.

Putting it another way, the problems identified all have something to do with poor financial management.

Owners and managers are typically only experienced and trained in, at most, two functional areas – in most cases, selling and product knowledge.

It should be clear that an additional knowledge set – financial management! – needs to be ramped up around the industry.

The easy way to fix this anomaly is to dump it all on the accountant or the book keeper to worry about.

However, it should be obvious by now that owners or managers themselves need a firm grasp of the principles of financial management and should be active in applying them to their own situation.

What does this entail? What are the objectives? What decisions does it involve? What tools and techniques need to be employed?

The general goal of successful financial management can be viewed in terms of two much more specific objectives.

The first of these is the Probability Objective, which is concerned with managing the flow of sales revenues into and operating expenses out of the store.

The second is the Liquidity Objective, which is concerned with managing the flow of cash in and out.

 

WHAT IS THE PROFITABILITY OBJECTIVE?

The Probability Objective is about maximising profitability by ensuring that every dollar invested by the owners or shareholders is put to its most efficient use – that is, the use which ensures the highest return.

The basic rule of financial management is that profits do not just happen, they are planned for and worked towards.

Profitability management is concerned with maintaining or increasing a store’s earnings through attention to:

  • Cost control.
  • Pricing policy.
  • Sales volume.
  • Inventory management.
  • Capital expenditure.

 

WHAT IS THE LIQUIDITY OBJECTIVE?

The Liquidity Objective is about ensuring that, as a minimum, a hardware or trade store is always able to meet its obligations (wages, creditors, loan repayments, and tax obligations, etc) in cash (i.e. from funds in the bank) as and when they fall due.

Ideally, the owner or manager works to avoid any damage to a store’s credit rating as a result of a temporary inability to meet obligations, by:

  • Anticipating cash shortages.
  • Maintaining the confidence of creditors.
  • Pre-arranging finance to cover cash shortages.

Conversely, the owner or manager should wish to minimise idle cash balances which could be profitably invested elsewhere – for example, paying suppliers to pick up early settlement discounts.

 

PROFIT ≠ GOOD CASH FLOW

The underlying reason for needing two objectives for good financial management is that profit does not equal cash flow.

Why do sales revenues not equal cash flow?

  • Because some products and services are invoiced out in a store, particularly trade operations
  • Because not all cash inflows result from sales (e.g. cash from a bank loan or new capital contributed by owners or shareholders).

Why do operating expenses not equal cash outflows?

  • Because most products and services provided to the store are received on credit.
  • Because not all cash outflows result from expenses incurred (e.g. repayment of a loan to a bank, purchase of equipment or dividends to owners or shareholders).
  • Because not all expenses involve a cash flow (e.g. depreciation of equipment and bad debts etc).

Over the whole life of a successful store, you would expect eventually that profit and cash flow would be equal, but in any period they would be different for any of the reasons above.

So it is the task of the owner or management to ensure that proper planning and control means one follows the other smoothly as the store moves from one period to the next – that is the objective of good financial management. 

 


Peter Cox has spent over a decade training and consulting in the retail hardware industry. He has conducted 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. Visit www.petermcox.com.au

You can read all of Peter Cox’s Money Matters articles from 2014 onwards here: www.hardwarejournal.co.nz/categories/money-matters/

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