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Peace of mind, cash and financial controls for SME owners.

Updated: Nov 4, 2020

By Michael O'Donnell

12 July 2018


With a number of small business owners, we ran a vox-pop survey to benchmark the businesses with best practices. The survey was anonymous, so no one was singled out. It was also non-judgemental. But one could see where one needed to be.

The size of the businesses surveyed were from micro businesses to ones with several million euros in turnover per year.

Without patronising the reader or telling them how to suck eggs, the comments below are intended to reach those business owners who are struggling without adequate financial controls, inhibiting their commercial decision making process to the next quantum.

Good financial controls and internal disciplines give a valuable commodity to the business owner: peace of mind. Peace of mind going into a sales pitch. Peace of mind regarding the welfare of your employees and stakeholders. Peace of mind to plan and appreciate and regard day-to-day struggles as mere operational challenges.


Q1 Commentary:

In a self-disciplined way, businesses of all sizes need to methodically and regularly review their assets and liabilities and be honest with themselves. Sarbanes-Oxley (SOX) introduced in America in 2002 following a number of corporate failures required businesses to inform owners and Boards of issues. One could no longer argue in Court that one didn't know - the business owner was deemed to know. However, for non-SOX environments, the principle is a useful controls exercise and should be considered in a business owner's overall review.


Q2 Commentary:

Action point: For normal SME's businesses (up to €100m turnover per annum), bank accounts need to be reconciled monthly at a minimum. Cash and Bank is the most basic indicator on business performance. No bucks, no Buck Rogers.

Performing annual reconciliations or not reconciling at all indicates that the business owner is operating on a hand-to-mouth basis and will not be prepared for an unforeseen situation or periodic cash heart-attack. Businesses (often volume retailers) with hundreds or thousands of transactions per day need to reconcile on a daily basis with a dedicated team.


Q3 Commentary:

The above survey said that on average a quarter of the debtor book was overdue. Whether this is serious or not depends on the risk and relationship with the client etc. Government and major businesses may be deemed lower risk, but it means less cash in the business to operate.

Sometimes it is commercially useful to retain a debtor who may open up new markets or opportunities; that they've an intangible value to the business. Once they pay their debt, they owe you nothing.

Regardless however, this causes lower working capital and affects liquidity.

Using the Pareto Principle, the business owner needs to work with their Credit Controller to rank and action the most serious overdue invoices and follow up as necessary. Essentially, 80% of the overdue invoices are owed by 20% of the clients. Those debts need to be targeted first.

In my experience, it is better to handle overdue debts in-house rather than factoring them out. The ideal person should be the Client Relationship Manager (CRM) involved from the start as that person has the warmest relationship of all. The conversation is on repeat sales, up-selling, value-add, work-expansion and other relationship building activity. If a conversation has stalled, then an escalation timeline needs to be established and followed.


Q4 Commentary:

At month end, outgoing invoices need to be created, approved and sent to clients at the earliest opportunity. E.g. Once the client's engineer has counter-signed the build's latest phase with our own engineer's work, then finance needs to be informed so the latest invoice can be raised immediately.

'Work in progress' (WIP) is used to value un-invoiced work at each month-end. It is often used by businesses as the metric for how projects are going. Any increase month-on-month needs to be taken up with the project manager at the formal commercial monthly meeting. Invoicing converts WIP into a debtor, which ultimately converts to cash. Obvious point often missed: Why allow your client to walk around with your money in their pocket?

Since 2018 there are now provisions in the Irish VAT regulations requiring invoices to be raised within a fortnight of when the service or product was delivered. The ulterior motive is that VAT and Sales tax is paid with minimal delay. There can be significant penalties of up to €4,000 per invoice for not doing this, so it's in the business' interests to ensure that invoices are actioned quickly.


Q5 Commentary:

Accounts Payable (AP) is the department that collects, codes and posts incoming invoices to the system.

In one particular role as a Financial Controller, regularly I'd be on the receiving end of the Marketing Director's rather unprofessional wrath, who'd taken a call from a furious supplier about non-payment. Upon investigation - each time - we found that the invoices were being sent to the marketing account executive's email and not to the AP department. As a consequence, we knew nothing and did not arrange payment until someone got upset.

All suppliers need to be advised of the business' AccountsPayable@ email to send their invoices to. This can be shown on the Purchase Order (PO) or on the commit-to-buy email sent to the supplier.

Why? A golden rule of business is: Pay your suppliers on time. Relationships deteriorate rapidly when your business gets a reputation for being a slow payer or not paying. Future quotes become higher as you become more of a risk. Ultimately, you end up having to pay in advance.


Q6 Commentary:

The last 10-20 years have seen extraordinary improvements to national tax authorities collection and administration methods. The processes needed and dates are largely well known and routine and shouldn't attract attention due to non-compliance. Any businesses who are consistently or occasionally failing to pay their Payroll taxes, VAT/Sales Taxes, Corporation Tax etc. needs to bring it to the attention of the owner as soon as it's realised and corrective processes established at once.

Some small businesses keep a bank deposit account set aside for tax payments. Rather than release the payment as soon as it's calculated - the cash is earning some interest. More importantly, it's not accidentally spent, yielding a penalty which can be eye-wateringly painful or a waste of cash.


Q7 Commentary:

Gross Margin is the first level of profit that the business owner looks at on his or her Profit and Loss a/c. At its simplest, it is the Sales less the expenses used to make those sales. This profit/margin needs to cover the entire business overhead costs, so having as profitable a set of products, services or bundling as possible is critical.

The business owner needs to periodically review the true profitability of the product and/or services range so that profitable activity can be reinforced and loss-making activities can be addressed or culled from the offering.

Markup and Margin

Often a business will aim to make (say) 30% Margin, calculated off their cost base and countered against market prices. However, they calculate it back-to-front and end up with 30% Markup, accidentally pricing too low and making a lower profit.

In the below first example, the costs were:

€700 / (1-0.3) = €1,000. This yields €300, a 30% margin.

In the second example, the Costs were:

€700 x 1.3 = €910. This yields only €210, a 23% margin. Less cash to pay for overheads.

Quartile analysis

I will post a separate article on performing a quartile segregation of your customer base to establish which businesses are profitable and those who are more trouble than reasonable. This can help improve overall profitability.


Q8 Commentary:

Both your direct costs and your overhead costs are the ingredients which contribute to your success. Like all ingredients they should be checked for freshness.

Marketing costs, Administration, IT & communications, Human Resourcing - even the accountants - should be reviewed on both a rolling and annual basis to ensure value for money.


Q9 Commentary:

Management Accounts traditionally comprise of the P&L a/c, Balance Sheet and Cash Flow Statement. All current accounting systems produce them on demand. The management accountant needs to be able to create value-add and analyse as appropriate.

One method we used at an American multinational was to report and explain variances +/- $3,000. Anything less were not material and were ignored unless requested later. This had an unexpected benefit in that the Group analyst in the UK had a threshold of $5,000 and because all his queries were already answered, we received no follow ups from him and had more time to improve reconciliation systems and work on projects.

For the Pack to be useful to you as the business owner, it should also highlight:

- A dashboard showing the salient points with commentaries

- P&L a/c (Monthly and Year to Date); Variances with Budget and Forecast

- Revenue analysis - showing Gross Margins for channels, product lines etc.

- Balance Sheet

- WIP (Work in progress) analysis

- Cash Flow (Actual)

- Cash Flow (Projected)

- Aged Debtor Listing, ranked

- Aged Creditor Listing, ranked; approvals to pay

The pack should be circulated by Working Day WD+7. The meeting with should not take longer than one hour. It may not be possible to cover all issues, so the material issues need to be addressed and not be allowed to get bogged down in minor issues.


Q10 Commentary:

As above in Q9, comparisons with Budget and Forecast are important.

The Budget enables the business owner to understand how well the original plan for the year has gone. A famous boxer described how no plan survives being punched in the face. However, while a boxer needs to vary his immediate tactics, remembering the original plan will remind him why he got in the ring in the first place, (once the stars begin to disappear...).

Having an established budget helps to communicate to the business exactly what the business owner's vision is for the coming year. We created a Group Consolidated budget for a large firm going from €78m to €102m intended revenues. The budget was as much a political exercise for the department heads as it was owning its numbers. It created ownership, responsibility and accountability throughout the company, empowering the senior management, rather than the Board having to take every decision.

The budget highlights under-spends such as perhaps a postponed recruitment drive, marketing campaign or lack of expenditure on new lap-tops. The budget helps the owner to drive the business goals.

The Forecast is an often forgotten exercise. It can usually be restricted to Sales forecasts and associated Direct Costs. Put simply, whatever we thought back when we created the Budget, if we continue as we're going, where are we going to be?

Sales forecasts from the Sales team can be optimistic. But the finance team will be overly cautious. The sales forecast needs to be reviewed with both teams as part of the month-end process.


Q11 Commentary:

Managing 'the List' is one of the key drivers to success. Some days the list ends up longer, some days it gets shorter. Reviewing progress on a monthly basis helps to retain and maintain momentum.

To quote a catchphrase of my shift manager when I was a student working in McDonalds: A time to lean is a time to clean.

Get busy.


Q12 Commentary:

As mentioned above, promptly issuing invoices is key to getting cash into the business. The longer that is delayed, the longer the client may take to pay, the more severe the cash struggle at the far end of the coming month when you're trying to protect the payroll.


Q13 Commentary:

At time of preparation of the original survey, there was no foresight of Covid19 and times were generally buoyant. Knowing your flame-out is important. Beyond a certain amount suggests that cash is not being used as productively or profitably as it could. Below a certain timeline, would suggest that the business is approaching insolvency and will struggle if and when the cash heart-attacks come.

We prepare a rolling 50-Day Cash Flow Forecast for businesses, and help them see to the day where their cash pinch points are. Please contact me for more information.


Q14 Commentary:

Working capital is the non-cash element to what drives your business. Cash is the best form of liquid finance within your business. However, management of other aspects will improve your cash position:

a) Debtors: Allowing your debtor levels to increase is bad. We're allowing clients to walk around with our cash in their pocket. Action: Collect cash on time and focus on the most material clients first.

Ironically, at an accounting firm, a problem we had was that our clients were not paying on time following the completion of our work. This was leading to the cash pinch-points for the business especially around payday. The partners were justifiably concerned and had had to fund the business. This led to internal agitations.

Our solution was to issue a Friday Flash Report, where we downloaded all Aged Debtors off the system. Then we ranked them in order of size and cross-referenced with the Director/Audit Manager who worked with the client. He or she had to make the call. We targeted the worst 20 debts the following week. The following week, there were a new worst 20, and so it continued.

While there was a degree of lighthearted and not-so-lighthearted naming-and-shaming initially, quite quickly the cash started rolling in very significantly and continuously. This took pressure off the partners who could reduce down their loan accounts, improve morale with staff nights out and action business expansion plans.

b) Creditors: Paying your suppliers too quickly (e.g. in advance or ahead of time) is generally unwise. The service hasn't been delivered yet. Action: Push for better credit terms.

c) Inventory and WIP: Retaining unsold stock or failing to invoice project work-in-progress inevitably reduces available cash.

By keeping control of clients, billing them when due, paying suppliers only when contracted to ensures that liquid cash is retained.


Q15 Commentary:

Regular checks of inventory and stock are important to businesses selling goods, but also to services businesses who have unbilled work-in-progress for clients.

- Stale and out of date stock

- Breakages and pilferage

- Obsolete stock

- Stock that cannot be returned

- Damaged and not for resale

- etc.

WIP and inventory if not regulary monitored and valued can have a material effect on the value of the closing stock. This can skew the value of the balance sheet and also misstate the P&L - making you believe your cost-of-sales (part of your direct costs) are better or worse than expected.

Stock detailed in your accounts system needs to be counter-checked against what is actually in the warehouse (goods) or what is logged on the project management system or CRM (for services)

Review your stock levels as often as your management accounting.


Q16 Commentary:

At time of writing in 2020, the economy has seen a major retraction due to Covid19. Small businesses have been crippled and numerous schemes have been promoted by government agencies to assist small businesses.


Q17 Commentary:

There is an equilibrium between the personal and business relationships we keep with our clientele.

Within reason, it's important to review the profitability of a client from a cost/hr perspective and compare them with other clients on the books.

A wise person knows the difference between price and value. Value isn't necessarily measured in currency. Choosing peace of mind with a stable steady-paying client compared to a high-octane but volatile client is a decision that needs to be reviewed, especially in the lead up to revising a contract or service level agreement.

What's worthwhile to you?


* Update: The Covid19 lockdowns in March 2020 and October 2020 have resulted in fundamental reviews of businesses, from discussions on viability to changes in objectives.

** Update: Contribute to the latest survey: [Click]

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