A very common mistake I see from startup and small business owners is they manage their business by checking their bank account. This happens because it is a habit we learned from managing our personal finances. It’s pretty easy to manage your family’s budget by checking the bank balance before and after you get paid every 2 weeks. You have a pretty good idea of what your balance should be and generally the money coming in equals the money going out and your bank account stays about the same.
The problem is you are not managing your family budget you are managing a company budget and what ends up happening is you set the average balance too high
You calculate a safety cushion to cover your expenses for 1 or 2 months and make that your target balance. Then you raise it higher than it needs to be because it feels good and like you are successful when you see that bank balance growing. And really you are not sure how much money to keep in the bank so you end up playing it safe and over saving and being overcautious.
The issue is that you are not investing in growth – you could hire new people, spend more on marketing, or invest in technology to make your company more efficient
So, the solution to this is to come up with a forecast to get a better idea of how much money you have coming and going out and what the extra surplus is. This is the function of a FP&A (Financial Planning and Analysis) Department. Each month you should do a variance analysis to continue to improve your forecast until it is fairly accurate and you have a certain confidence level of what your surplus will be each month.
Then comes the fun part - figuring out the best way to improve your company
FP&A can also help figure out the best and smartest way to invest your surplus. We can do scenarios to figure out if you should launch a new market or if you should hire a sales person or spend more on Google Ads. And most importantly if your business starts to change and your surplus is shrinking then FP&A will be able to figure out why and come up with suggestions to improve the problem.
If you are not profitable or have cash issues, then it is even more important to know how much money you have coming in and going out each month. If cash is tight there are lots of things you can do on a short term basis to free up cash. The more important thing is to understand your business so you can figure out if there are any levers you can change to improve profitability and cash going forward.
But what if my company does not have a surplus?
What is the easiest way to start?
The quickest way to start is to export your last 3 months profit and loss statement and see how each line item is changing. Some like rent or payroll should be pretty constant assuming that nothing is changing. Revenues are usually the trickiest and forecasting cash can be even harder if you have customers that are not paying on time. You can start by looking at the month over month trend and then eventually changing to a driver based forecast, which forecasts the things that impact revenue like number of customers and revenue per customer.
If you need help then Finance Pals would love to give you some free tips over a 30 minute phone call. We want to help you understand your business better so you can determine your surplus money to invest in making your company better 🙂