First on the list is…

1. Improve your accounting data. Cash is the lifeblood of any business.  Start improving your business by understanding your cash flows.  What products generate most of your profits and therefore your cash?  Develop daily, monthly and yearly accounting forecasts.  Ensure your data is timely and available in real time so you can respond to changes quickly.  Charting your data is one of the seven quality tools.  Consider charting your data to look for trends and then take action on those trends.
2. Price your products and services more appropriately. Pricing is not easy.  Whole books are produced on pricing products.  But there are some simple rules of thumb.  Raise prices on your high quality items and lower prices on your low quality items.  The idea is to focus on customer value not your cost of production.  If your items are high quality then say it with your price.  Don’t be afraid to raise your prices on those items that your customers really like and lower prices on the items they don’t like.  If you are not sure what your customers value, then ask them and they will tell you.
3. Hire the “right” people. Focus your employee hiring process on hiring great attitudes not personalities.  Great people are performers that demonstrate results.  Look past skills on a resume and look for great accomplishments.  Remember, good is the enemy of great so hire great people not people that are good enough.
4. Fire the “wrong” people.  If you have made a mistake then don’t be afraid to fire someone that is not working out.  If it’s not working out you will know it in the first 90 days, so end it now.  Don’t wait for improvement in your finances or their attitude.  Firing should be done sooner rather than later.  Nobody likes to do fire others, but your business health is more important.
5. Develop standards. Products have requirements and so does your business.  Define what “great” is for every job or process that is critical to your business.  Start with a process map and then create policies and procedures for each job or process and use them.  Benchmark your competition and set a higher standard for yourself.
6. Implement controls. Controls start with clearly defined objectives for every job or process that link back to your accounting system and the forecast.  Take time to understand what can go wrong and work to prevent it from happening.  Develop warning flags to indicate when things are going wrong.
7. Focus. A working management strategy requires focus.  Focus on the one thing that will make you great.  Budget your resources to grow your star opportunities and starve your problem poor performers.  Basically, get everything out of the way of your star opportunities.
8. Improve your sales process. Sales is a contact sport so make sure you are getting out in front of your customers often.  Build relationships with customers so they buy again, and again.  If your revenues are not growing then you are not selling. 
9. Understand your marketplace better. The marketplace is not static so expect it to change.  Understand what’s changing in your marketplace and either change with it or be changed by it.  Pay attention to what your marketplace needs and give it to them before your competition does. 
10. Build a strong brand. Your brand leads the business.  A filing brand leads to a failing business Marketing, vision and strategy are key elements of building a strong brand.  Once your brand is built, maintain your brand and what it means by following the other nine points above.  Don’t let your brand suffer or else your business will suffer too.

There you have it.  10 ways to improve your business for the new year.  Don’t delay.  Get started today by ordering policies and procedures in MS-Word templates.

Top Ten Ways to Improve Your Business

1. Improve your accounting data.
2. Pricing your products and services more appropriately.
3. Hiring the “right” people.
4. Fire the “wrong” people.
5. Develop standards.
6. Implement controls.
7. Focus.
8. Improve your sales process
9. Build a strong brand.
10. Understand your marketplace better.

While this condition certainly exists in many businesses, it is far from ideal. When all segments in your business are not functioning, well, it leaves your business vulnerable. When sales fall or production quality drops, can your business survive if it does not have a solid structure with sound best practices?

How Important Are Financial Policies and Procedures In Your Business?

Public companies pay a lot of attention to financial results because they are required to — by the SEC, shareholders, their Board of Directors, and hopefully by management too. Yet, many small and medium sized businesses often times fail to pay attention to their overall financial processes and structures. Maybe it’s because the same oversight and shareholder pressure just isn’t there.

If you run a business, you know that cash flow is the lifeblood of your business. So you would think that having a balanced approach to financial policies and procedures would be more common than it is. Yet, operational concerns get more attention when it comes to writing policy and procedure manuals. The goal should be to strike some kind of balance between paying attention to financial matters and the other aspects of your business such as operations.

In their important work The Balanced Scorecard, Kaplan and Norton discuss four business segments that require focus in some balanced way. (Note: The idea of balance should not be taken too literally – it is not about having perfect balance in all areas of business. Some areas may take priority. The point is that to be successful a business needs to pay attention to, and work to improve in, all key business areas.)

The four segments presented for a balanced scorecard include:

• The Customer
• Learning & Growth
• Internal Processes
• Financial Measures

This should be viewed as a minimal list; your organization might identify other areas that require attention in a balanced way. Success in financial areas alone cannot translate into overall success if the business does not have good products that are delivered in a timely way that satisfies customers. While financial operations are important, they should not be the exclusive focus of management, no matter how large or small the business.

Financial Policies and Procedures Balance

That Finance is listed as one of the pillars needed for business success in the Balanced Scorecard does indicate its importance in the overarching view of what in required for businesses to be successful. Surprisingly, however, studies show a large number of medium and small businesses do not proactively manage financial processes such as developing financial strategy or conducting financial analysis. If you are one of these business owners, you need to take a look at building a financial policies and procedures manual. Producing your own finance manual will help you incorporate best practices and a systematic approach to finance, cash flow, and even raising capital when you need it.

That is why Bizmanualz has written a financial policies and procedures manual to assist you with balancing the key aspects of your financial operations including: regulatory compliance, improving performance (through well-defined processes) and implementing best practices into operational areas like Raising Capital and Treasury Management. The finance manual describes, in procedure form, best practice activities needed to manage financial processes to achieve regulatory compliance and improve financial performance.

Each financial procedure is guided by a stated finance policy, and an accompanying purpose of the procedure. Each procedure also comes with financial forms that are typically used to collect information and data as part of executing the procedure. The policies, procedures, and associated forms can be easily edited in Microsoft Word allowing you to customize all procedures and forms to meet your individual organization’s needs, or use them as finance templates to create additional company procedures important to your financial operations. Download Free Financial Policies and Procedures Samples to see for yourself how easy it can be to develop your own policy and procedure manual.

When you deliver goods or services and you extend a business customer credit by accepting a promise to pay later through an invoice, then in a sense you are loaning your customers cash.  What steps can you take to make sure you get your cash back?  If you use good cash management practices to protect yourself from your employees and co-workers, then shouldn’t you be taking the same precautions with those outside your business?

Your Credit Policies Are a Part of Proper Cash Management

Of course, we are talking about a proper credit policy for clearly establishing the process of determining who can receive credit (can “promise” to pay later) and how much credit they are allowed.  Since determining credit may not always be a straightforward matter, a credit manual that includes credit policies and credit procedures, as well as clear explanations of the strategy or intent behind the policy, can be very useful.  Communicating the purpose behind credit policies can be a great help to those making the credit decisions.

Clearly communicating information about the how the company wants to extend credit is one important goal of your credit manual, credit policy and procedures.  Another important goal is to create consistency in how you handle and extend your business customer credit, both internally and externally.  But most importantly, your credit policy is about risk reduction.  It should be created in advance and take into account such things as its effect on sales, the impact on the company’s cash flow, and legal liability.

A Credit Manual Communicates Credit Policy and Intent

Internally, the credit manual can be an instrument to get various departments on the same page when it comes to customer credit.  For example, the accounts receivable department and the sales department are frequently at odds regarding what the credit policy should be.  Accounts receivable wants tight credit so they can collect within the proper period and not deal with delinquent accounts.  Sales, obviously, wants to book sales and they are not prone to turning away customers.  It is management’s job to establish clear credit policies and clear credit procedures, as well as explain the reasoning, in order to minimize the inherent conflict created by varied interests of these two departments.

Although it is frequently overlooked, part of the credit process should be regular communication between the various departments involved with using the credit policy manual.  Imagine the synergy created when accounts receivable, collections, sales and marketing, and even design and production all agree and cooperate in managing business customer credit.   The sales department knows and agrees not to waste its efforts on customers who don’t pay, and those making credit decisions know and agree when exceptions need to be made.

A Clear Credit Policy Helps Extend Credit Wisely

Besides establishing consistency internally, the credit manual can also ensure consistent and fair treatment for external customers.  The ability to extend short term credit is an important business tool, and if customers feel they are being treated unfairly or without a modicum of trust or respect – it can mean lost business.  When it comes to completing credit applications, references and credit checks, a certain level of consistency is expected, and this is especially true for making credit decisions.  The name or size of the company should not be a major factor in deciding who gets credit.

For example, I recently worked with training at a large construction company, and one of their regular customers was somewhat of a celebrity businessman.  Apparently, as a matter of practice, this well-known businessman delayed payment of owed invoices until they fell into collections, and then he would attempt to negotiate to a lesser settlement amount.  Eventually, however, the construction company had to tell their customer “you’re fired.”  By the time they considered the delay, the collection efforts, and the reduced payment, they were lucky to break even.

Apparently, this person relied on people wanting to do business with him because of his celebrity status.  You can’t, however, put a customer’s well-known name or brand in the bank to cover your payroll and your own accounts payable.  Your company is better off finding lesser known customers who pay their bills.  Consistent and fair company credit policies can help make sure that happens.

Cash Controls Include Company Credit Policy

Your credit manual and credit policies and procedures are directly related to protecting your cash, and you should understand that component as you develop and update them.  But just as critical as development of the credit manual is how clearly you communicate your policies and procedures clearly to all affected parties in your organization.  Poor credit practice is tantamount to leaving you cash drawer open… maybe no one will take advantage of your carelessness, but why take that chance?

Cash Management is Vital for Internal Control

Sloppy approaches to cash management can lead to temptation. Employees handling a significant amount of cash carry the greatest opportunity for fraud or abuse. Cash handling procedures are used to minimize cash handling risks. Multiple cash counts by different people make the basis of sound cash controls.

For example, the same person who handles the money should not be the one accounting for it. Cash funds should be counted often and by at least two people. Different people should handle cash, checks and deposits from those who record them in the books.

Cash handling procedures are one area auditors examine. Poor cash management policies and lack of control over cash handling will certainly make a poor impression, and possibly even impact an auditor’s perception of your accounting practices. Good controls using cash policies and procedures that are clearly communicated and regularly audited internally indicate to external auditors that cash controls are working.

Cash Policy and Cash Procedures Set Organizational Tone

Not only do proper cash policies and useful cash procedures send a clear signal to auditors, it also creates the required operating environment for employees. Due diligence and transparency involving regular management activity (including creating and updating cash policy and procedures) sets a tone that professionalism is the standard. Mistakes that are quickly caught and corrected convey a clear message about the importance of proper cash management.

Understanding key elements of your business, setting the proper environment for employees, creating a positive impression for auditors; these are just some examples of how proper cash policies and procedures can help your business. If you don’t feel you have the proper cash management controls in place, it is never too late to start. Begin by understanding your cash processes and identify what is important and what risks you face. Address them by creating cash procedures that incorporates data collection and review as well as the typical controls such as second person reconciliation.

If your business relies on cash flow, as most do, why would you leave cash management to chance?

No Financial Strategy Means a Strategy for Failure

We have covered how important it is to create clear financial strategies several times in past articles. Do you think the organizations handing out bad loans, buying securities of bundled bad loans, and selling credit default swaps had a well-thought out financial strategy for business success?

If the financial strategy was expressed at a now defunct mortgage lender, what would it have sounded like?

Mortgage Lender CEO to Board of Directors and Executive Staff:

Okay – here is the plan folks. We are going to give people mortgage loans for hundreds of thousands of dollars. Before we write the checks let’s not do any due diligence by verifying their financial information like income and credit background, or even by making sure we have accurate information about what the home is worth. Just to keep it interesting, let’s throw in some curveballs like unrealistic low beginning payments followed by crippling rate increases and ballooning payments, no matter what the prime rate is doing. Then, when our lendees can’t make payments and foreclosures start skyrocketing, the bottom will fall out of the housing market. Once that happens hardly anyone will be buying and selling houses, no one will be getting loans, our cash flow completely dries up, and we will be out of business in no time.

Does that sound good to everyone??

Board of Directors and Executive Staff: Hear Hear!! Bravo!!

Mortgage Lender CEO: Alright! Let’s get out there and make it happen!!

It sounds kind of ridiculous when you say it out loud, doesn’t it? But what did they THINK would happen? Did these organizations not have any strategy at all?? Apparently they were thinking: let’s just keep writing loans and charging fees as long as there are people who want them. There was apparently no clear plan or vision regarding what these activities meant for the future of the organization. No strategy is a strategy for failure.

Strategy Management Incorporate Goals, Environment, and Risks

A clear strategy and plan not only incorporates goals and the activities needed to reach these goals, but it also addresses risks. Obviously, the risk of handing out loans for hundreds of thousands of dollars without the proper due diligence and transparency was not accounted for in managing the financial strategies of these organizations.

Of course the above scenario of formulating a horrible strategy never really happened, but that is the point. Having no strategy is really the equivalent of having the worst possible strategy. The same concept moves right up the chain from the mortgage sellers to the investment banks who were buying and selling credit default swaps that they couldn’t cover, and to investors who were buying bundled securities that turned out to be virtually worthless because the real value was indeterminable.

Business Success Takes Planning

Conversely, you can find examples of businesses in the financial industry where a well-thought out strategy prevented them from being another victim of the financial crises. Perhaps the most visible is Bank of America. Executives at this institution say that they made a conscious decision about eight years ago not to get involved with the sub-prime loan market. They just didn’t see how lots of risky loans fit their long term financial strategy. Now, while so many other financial businesses are facing catastrophe, Bank of America is strong enough financially to grow by snapping up bargains. Recent acquisitions include well-known organizations like Merrill-Lynch, MBNA, and Countrywide Mortgage.

Anyone who has ever watched It’s a Wonderful Life knows that the best time to buy is when others are panicking and selling. But, of course, you have to be in a position to buy; and that is usually the result of a well-thought out and managed financial strategy.

How important is a clear financial strategy? Apparently it can mean the difference between growing your business and going out of business.

Financial Strategies are the Starting Point of Internal Control

For strategies to be effective, however, they have to be communicated and implemented throughout the organization. That means operations in various departments at various levels have to create their own strategies and plans that align with, and execute, top level strategies. This is accomplished though training, policies, procedures, and implementing best practices – an excellent starting point for internal control.

One final point. Most businesses cannot survive on a good financial strategy alone. A good financial strategy, for example, doesn’t mean much to a business without customers. So thoughtful strategies must be created and implemented across the balanced scorecard: finance, customers, internal processes, and learning and growth.

There are never any guarantees for business success, but creating financial strategies gives your business direction and guidance. Without that, there is no telling where you will end up. Perhaps owned by Bank of America.

Still, many stock holders, business owners, managers, and even employees express concern over whether their organizations are ethical and whether members at all levels hold themselves to a high standard of conduct. How can you improve the confidence you have in your organization’s ethics? There are several basic steps you can take.

Create a Plan

The first step, as should be the case with any initiative, is to create a clear plan that focuses on addressing particular situational needs of your organization. An organization where lots of members handle lots of cash would be very different from an organization where cash flow is only purchase orders, invoices, and checks. Where are the significant risks? If there is little risk in employees pilfering cash then why make a lot of effort in developing stringent cash controls? You should put you efforts elsewhere.

While each plan should be unique to fit the organization, typical activities would include items such as improving the hiring process, clear communication of the ethics policy and codes of conduct, establish a systems of checks and controls to ensure wrongdoing is discouraged and discovered in a timely manner, and finally a clear policy and procedure for investigating and handling breeches in ethics appropriate to its level and severity.

If the idea of detailed analysis of risk and risk management through an ethics plan seems overwhelming, you can consider hiring an outside consultant. Someone with expertise in this area can guide you through the process quickly and effectively so the program has legs and it is not just another great idea sitting on the shelf because no has the time. It can be well worth the money invested; imagine the devastation to your business and your reputation if a scandal makes the press.

Follow through with Action

Once you have identified needed steps to improve the ethical environment of your organization or department, make sure you follow through by caring out the steps. Hold the training classes, circulate the code of conduct annually with each employee signing a statement that they have read it and will comply. Follow the plan for hiring even if it is inconvenient to check references and background.

Where needed, as identified by the plan, develop clear policies and procedures for key processes, and then conduct training to ensure all relevant employees understand the expectations of how processes should be carried out. This could apply to any area of the business, from cash drawer handling to proper disposal of hazardous materials in the production area. After all, an investigation and a fine by the EPA could be more damaging to your business finance and reputation than minor cash pilferages.

Once again, make sure all ethical needs of the business are being addressed. Owners and executives tend to focus only on cash, accounting, and finance, but, as the above example shows, ethical behavior in all facets of the operation can be just as important.

Clear policies and procedures communicated and followed by organizational members is a critical piece of an internal control, as recognized by organizations such as COSO. They can aid in meeting compliance requirements and with objective setting and measurement – the key to improvement.

Ethics Is a Part of the Organizational Culture

Besides developing and executing a plan, the most important way for a business to improve ethics is for the organizational leaders to display the highest degree of ethical behavior in how they conduct business on a day to day basis. Is it fair to require employees to meet expectations of the highest ethical conduct, when day in and day out, they see the leaders of the organization showing little concern for customers, delaying payment of invoices, and blaming subordinates for their own mistakes?

While establishing codes of conducts and controls is important, many members of an organization will take their ultimate ethical cue from those who they feel are responsible for making decisions and setting the tone. The bottom line is that the organization will be as ethical as its leadership. So when developing policies and codes of conduct, the first ones in line for buy in and incorporating them into daily activities should the ones in leadership positions.

If you need assistance with developing policies and procedures, Bizmanualz can help. We have a full line of off-the-shelf policy and procedure manuals that address key business segments such as Computer & Network, Accounting, Finance, and Sales & Marketing.

The articles in February revolved around financial issues such as financial controls, working capital, return on investment and cash flows.

Discussions of improving processes are too commonly relegated to the production floor. Is it any less important for your office processes to function effectively and efficiently? How well does you company manage financial aspects like working capital, debt and investments, and leasing? These are just as vital to success as how efficiently production operates. Yet, few companies attempt to understand and improve finance processes to the same degree.

Meaningful Financial Controls For Positive Results

Do you know if you are making money on the cash you borrow? Or how about the assets you deploy like accounts receivable, inventory, or cash? What about the asset acquisitions you make? These are hard questions to ask for some but when it comes to business finance, these are the questions you should be asking – before you raise debt or equity capital.

Read more about financial controls and positive results;

Do You Have Enough Capital ?

Your capital needs are based on your revenue growth and your cash flow situation. Revenue growth comes from increasing the sales of your products or services, which in turn requires increases in expenses, assets, and working capital to fulfill those sales. This may seem obvious, but what is not so obvious is that there is a ceiling to this growth. Your growth is limited to your growth in equity.

Read more about capital needs and cash flows;

What Is Your Business’ Return On Investment ?

Returns are a function of risk; typically the higher the return the greater the risk. Thirty-year government bonds are low risk with returns in the 3-5% range. The overall stock market is more risky but produces an 8-13% return. Small or new businesses are considered the most risky, which is one reason why venture capitalists require average returns of 25-30%.

Read more about your business’ return on investment;

Putting Your Financial Resources To Work

Working capital is the money it takes to run your business on a daily, weekly, and monthly basis. It is the money used to pay your suppliers for materials and the money needed to pay for the goods and services (i.e. inventory and payroll) you have used while you wait for your customers to pay you.

Read more about working capital and financial resources;

Taking control of your financial processes increases the chances of your business’ success. Later this month, Bizmanualz will be releasing the Finance Policies, Procedures & Forms manual, introducing the concept of well-defined and controlled processes to Finance. It can be the first step in understanding your financial processes, and ensuring you receive maximum benefit from your financial resources.

On That Note

Answer to this month’s question:

Treating important company activities like finance from a process point of view is one method to realizing improved performance. When it comes to managing processes, finance is not that different than producing products and services. Productively using financial resources avoids undesirable results like big receivable/payable balances, low returns or unhealthy debt-equity ratios. Improved financial processes can result in effective financial controls and contribute to the company’s success.

Please feel free to contact us with any questions or comments. Our policies, procedures and processes articles site has tons of useful information. Also, please let us know if you’d like any specific topic addressed in our future articles.

Regards,
Chris
Bizmanualz

Our final topic on finance processes is about working capital. Working capital is the money it takes to run your business on a daily, weekly, and monthly basis. It is the money used to pay your suppliers for materials and the money needed to pay for the goods and services (i.e. inventory and payroll) you have used while you wait for your customers to pay you.

There are three important areas that companies should actively manage in order to get the most from their working capital. Here’s how they are related:

working capital = accounts receivable + inventory – accounts payable

Accounts Payable

Accounts payable is perhaps the easiest process to control because it simply involves paying the bills. But paying bills shouldn’t just be left to chance; there should be clear policies and goals that direct these activities. But generally, when it comes to paying bills, The Golden Rule should apply. Treat others’ invoices as you wish others would treat your invoice. Basically, that means pay it on time according to the terms. There may be no advantage in paying early, but purposely paying late as a working capital management tool is unprofessional and can negatively impact your business.

You may think you are getting away with paying your bills late, but in reality, if the organization you’re paying late has their act together, then your delayed payment may eventually result in increased prices or reduced service levels. While you may be the customer, do you really want to run you business in a way that elicits frowns and curses when your name is mentioned? Building such a negative reputation can have long term detrimental repercussions.

Ensure you policy states that payment will be made according to terms, with a goal of mailing payment five business days prior to the due date or having funds transferred on the due date for electronic payments (and a supporting measurement that clearly indicates performance in relationship to the goal). The accounts payable policy should also clearly state when invoices should be paid early.

Accounts Receivable

The cash flowing into your business as a result of customers paying invoices is crucial in managing your business’ working capital. Your organization should be actively measuring Days Sales Outstanding (DSO). DSO is the average number of days it takes to collect payment after the sale was made. Typically calculated as [(Accounts Receivable / Sales) X (Days)]. Days would be determined by the period for which you are calculating DSO; for example 30 if you calculate it monthly and 90 if you calculate it quarterly.

One key to managing Account Receivable is to remove delay in invoicing customers after shipment of an order or delivery of a service. These delays consume cash available as working capital. Set a goal to invoice customers immediately after fulfillment. If it currently takes 10 days to invoice a customer, then the goal should be to do it in 5. If it currently takes 5 then the goal should be 2 days. Finding ways to reduce the DSO frees cash formally tied up in receivables so it can be used in ways that provides return and fuels growth.

Prompt invoicing is the most important method to reduce DSO. It is something you have direct control over, plus, why should customers be conscientious about paying your invoice in a timely way if your make little effort to send invoices promptly?

Inventory Management

Including inventory as a finance function sometimes causes confusion and skepticism. There is no doubt, however, that inventory consumes financial resources; whether in the form of purchased materials/parts, work-in-process, or finished goods. Those responsible for managing the company’s financial resources and performance should also have the ability to oversee and monitor all three types of inventory.

The purchasing representative might believe they are getting a good deal by buying one years worth of parts, and perhaps they are. But making such decisions impacts the overall financial resources consumed by inventory, especially when you include the cost of ownership.

The responsible financial authority should stay informed of inventory performance, and in response set clear policies and goals for reducing and managing inventory levels through metrics such as Inventory Turns (the number of times that a company’s inventory cycles or turns over per year), Days Inventory (the average number of days of inventory on hand per accounting period), Average Inventory (the starting inventory number at the start of a period minus the ending period inventory number divided by 2), and Cost of Ownership (the total cost of maintaining inventory such as warehouse space including utilities and maintenance, finance costs, personnel, equipment, shrinkage, obsolescence, and insurance).

The overarching goal should be to find ways to reduce all types of inventory while ensuring operational needs are being met. This, as with accounts receivable, releases cash tied up in non-productive means so it can be used to gain return or grow the business.

Managing the working capital processes is just as vital to business success as producing products and services that customers want and that fulfills their expectations. Businesses not actively managing their working capital may find an exorbitant amount of financial resources being consumed in unproductive ways such as growing accounts receivable amounts and hefty inventories.

Taking control of your financial processes increases the chances of your business’ success. In the coming weeks Bizmanualz will be releasing the Finance Policies, Procedures & Forms manual, introducing the concept of well-defined and controlled processes to Finance. It can be the first step in understanding your financial processes, and ensuring you receive maximum benefit from your financial resources.

To learn more about changing your paradigm and using process improvement programs for your organization then attend the next How to Align a System of People and Processes for Results class. If you are eager to learn more about creating more order out of the chaos you are feeling at work then the How to Create Well-Defined Processes class is right for you.

ISO 9000 Internal Auditor classes are forming now. Call for information on having your own private in-house classes today.

There are two main processes at work in any organization: capital planning and working capital management. In the next two weeks we will look at how the capital planning process works.

Checkbook Accounting

The most common form of working capital management is what many refer to as “checkbook accounting”. In other words, if you have money in the checking account then you can write a check to cover the expenses, if you don’t then some payable is going to be put off until next week. Sound familiar? While this might be how many small organizations execute financial control (and perhaps how many individuals manage their own finances), it is not an effective way to manage your business finances.

The opposite can also be true. Cash can pile up in your checking account faster than you can spend it. So, at some point we have to start planning our capital strategy, which begs the obvious question – How much capital do you need?

Capital Needs Analysis

Your capital needs are based on your revenue growth and your cash flow situation. Revenue growth comes from increasing the sales of your products or services, which in turn requires increases in expenses, assets, and working capital to fulfill those sales. This may seem obvious, but what is not so obvious is that there is a ceiling to this growth. Your growth is limited to your growth in equity.

Equity increases either as a result of adding to retained earnings, which comes from your profits, or by asking investors to invest in your business. Here is where profit becomes important. Since profit is taxable, many would prefer to report as little profit as possible in order to reduce their taxes. Profit, however, adds to retained earning to create equity growth and allow for increased debt capacity via your debt-to-equity ratio. We need profit to fuel future revenue growth, and profit is what is demanded by investors.

If your revenues are growing faster than your equity then you assets must be growing too and since assets = liabilities + equity then your liabilities must be growing faster than your capacity to pay for those liabilities, i.e. your equity. Therefore, your equity equals your capacity for growth. If you don’t grow your equity in line with your revenues then you will be running out of cash and be forced to raise capital. The first choice for many may be debt but, your debt load is bounded by both your debt-to-equity ratio and your Earning Before Interest Taxes Depreciation and Amortization (EBITDA) or cash flow.

Your debt-to-equity ratio is calculated by dividing your debt by your equity. A ratio of one or less is considered good, whereas ratios greater than one starts to increase the lenders risk. Risk tolerances vary by industry so there is no golden rule above one.

Operating Cash Flow or EBITDA

You can only borrow debt up to your ability to make debt payments with your operating cash so your debt is bounded by your EBITDA, which is a measure of your operating cash before finance expenses like interest or tax expenses like depreciation. Since depreciation and amortization are non-cash expenses for tax purposes, EBITDA represents the raw cash produced. (Note that interest is usually a deductible expense so as you increase your debt you also increase your interest expense, which lowers your taxes paid.)

Profit Drives Growth

We have seen how profit is used to drive growth, which is one aspect to cash needs. The other side is based on what you are going to do with the cash. You can purchase assets, use it for other expenses, hold it, pay down debt, or give it to the shareholders. Think of spending cash as investing, and investing is about understanding the Return On Investment you are about to make. Next week we will look at how Return on Investment is used to understand the real Cost of Capital and what do you do if you have too much capital in your business.

To learn more about changing your paradigm and using process improvement programs for your organization, attend the next How to Align a System of People and Processes for Results class. If you are eager to learn more about creating more order out of the chaos you are feeling at work then the How to Create Well-Defined Processes class is right for you. ISO 9000 Quality Auditor classes are forming now for Internal Auditor or Lead Auditor. Call for information on having your own private in-house classes today.

This month, the focus of our articles was on core process flows, innovation and problem solving. A typical company has three core process flows – cash cycle, manufacturing (or fulfillment cycle) and design cycle. Your cash cycle reflects how cash is coming into your organization. Your manufacturing cycle includes your three inventory related processes—purchasing, production and sales. Design flow is iterative as it goes through multiple improvement cycles.

Cash and Manufacturing Flows

With cash flows, an unbalanced cash cycle produces negative cash flow and the need for increased financing. It is the same with the manufacturing flows. Unbalanced manufacturing flows require more inventory to compensate for all of the variation and unknowns, which increases your inventory, and in turn, your working capital needs.

Read more about cash flows and manufacturing flows;

Design Flows

In manufacturing and cash flows our goal is to work towards zero defects and doing it right the first time. Both are laudable goals for replication processes that are already designed but how do we do that for iterative processes like the design phase? In design we do not expect to have zero defects the first time.

Read more about design flows;

Thinking Outside the Box

One way to solve problems is by using known solutions. Problems with known solutions are solved with basic research into standard solutions that have been used before to solve problems of this nature. Hence, the problem is solved with a known solution. The key effort needed to solve such a problem is research. But how do you find unknown solutions?

Read more about inventive problem solving ;

In design it is possible to replicate using common design concepts like TRIZ to improve our ideas in a systematic way and not have to iterate through 10,000 different ideas to solve a problem. Design flows do differ from manufacturing or cash flows based on the principle of iteration but we can also find solutions faster by replicating known theoretical solutions to continuously innovate and keep the design cycle moving .

Reader Feedback

Several of you have asked us what you get when you purchase our manuals. All our hard-copy manuals come with the following:

• Three-ring color binder
• Printout of all content (three-hole punched)
• A CD that includes all content in MS-Word files for easy editing and customization.

Bizmanualz procedure manuals help your in your policies and procedures project by providing you a solid starting point. The procedures templates can be used as guides to write your own company-specific policies and procedures.

As always, thank you very much for all the feedback you have given us. And, remember to keep your comments, questions and suggestions coming.

On That Note

Answer to this month’s question:

The basic difference is the process type. Manufacturing flows are replication processes. You want to do the same thing over and over again—make all products in a run the same—by following a established set of procedures and processes. Design flow, on the other hand, is an iterative process and goes through multiple refinement cycles. You can’t get design right the first time, you have to keep on improving the previous designs until you reach a point where it meets your manufacturing requirements.

Please feel free to contact us with any questions or comments that you may have about our products, services or articles. Also, please let us know if you’d like any specific topic addressed in our future articles.

Regards,
Chris
Bizmanualz, Inc