It's A Breeze

More often than not the motivation to go into business is to deliver your gift. By default, in order to survive long-term you need to become a Financial Expert on your business. In an attempt to achieve this many business owners manage their business’ finances as they would their household finances. However managing business finances are very different to managing the household budget. 

There are three significant differences:

1. Volume of Cash Flow

The volume of transactions in a business will surpass that of the average household at some point in the growth cycle of a business. As the volume of transactions increase, so too does the volume of cash flows and the level of difficulty in managing them. To make sense of high levels of transactions in a timely manner they can be summarized into like categories so they can be viewed as a whole rather than single transactions.

To enable this a business needs a sophisticated structure in order to capture this data and summarize it into a form that is informative and easily comprehended. Hence the need for computerized databases, accounting rules and regulations and a set of financial reports.

2. Predictability

There is a sense of predictability about the household’s finances. 

Income is usually set at a fixed amount and flows into the household at a similar time. Wages are paid by a schedule and at a fixed amount. Even income from investments are usually received at a fix time and relatively the same amount. Payment for services and products for the household will also occur with predictability, some more than others. Rent will have fixed time frames and amounts. Utilities may vary slightly due to consumption levels although will be billed regularly. Even entertainment expenses will occur at similar times and at affordable amounts.

In the business, the level of predictability is directly a result of business activity which can increase and decrease dramatically. More often than not expenditure will need to occur before you receive the cash it generates. The timing of the two need to be managed so you have the cash for the expenditure in advance of receiving the income and that you don’t receive the income too long after the initial cash outlay.

The key to manage cash in a business, requires understanding of how money flows into, around and out of your business. When you understand these flows you can streamline them and minimize the dramatic fluctuations in your bank account.

3. Consumption v Cash-Generation

Household finances are essentially based upon a consumption model.

Income comes in and is spent on services and products so we can enjoy a particular level of lifestyle. These services and products are consumed and will need to be replaced once their value has been exhausted in full or we no longer receive a benefit.

Utilities and food, once consumed are gone forever and to obtain their benefits again, we need to re-purchase them. A car, whilst it will provide us with a benefit long term, is also consumed over time and needs to be replaced. Even a home we have purchased – when we extract more value than a roof over our heads, at some point the value we obtain will lose its luster and we may want to replace it.

Investments may be made increasing the cash flowing into our household, however we still consume the benefits of having additional income available to spend on products and services.

Household finances are therefore a consumption based model.

Business finances are a cash-generating model. The objective of the commercial entity is to make money by spending less than what we earn. To achieve this we spend cash on products and services that will generate more cash flowing into our business.

If you spend money on labor to provide a service and that labor costs more than you charge the receiver of that labor then you have increased the cash that flows into your entity. If you give the labor provider a car to transport them to and from your clients, you have in effect enabled them to do their job and increase the cash flowing into your business. If you pay rent for the use of a facility, then you get the benefit of having a place for that labor to work and generate that increased cash flow.

The cash-generating model is more sophisticated than the consumption model. In turn business finances are more complicated than household finances and require skillsets that as a business owner you need to learn if you are going to be more effective with managing your business.

I hope this has helped you to develop an appreciation of the need to upskill yourself in regards to business finances and how the finance function is an asset that needs to be maintained and managed.

In the meantime, keep those businesses humming.

Deb