Why You Need to Create a Financial Framework

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In the face of the global COVID-19 crisis, many businesses have been struggling to keep going. And a number have even shut down left and right.

Crises like these are unpredictable. No one wants nor anticipates them, and yet, small as the chances are to experience it, they affect even the best of us.

Because the likelihood of such problems arising feels like one in a billion, many business owners tend to overlook this possibility and fail to take stock of it in their financial planning, if they have any strategies in place at all.

It’s unfortunate what we’re going through globally, but as hunger for progress has always been part of human nature, it’s best to have the mindset that there’s nowhere to go but up, amidst this pandemic.

And it’s precisely because of the world’s fickle nature that we have to find ways to be resilient in keeping our small businesses up and running. We have to be prepared for anything and everything, miniscule as the chances for these unexpected disasters are. 

To help with that, I previously talked about the importance of maintaining a positive cash flow and gave you tips on how to do just that.

Now that you have a better understanding of cash flow, revenue, and profit, I highly suggest that you start building out a sturdy financial framework to ensure you can make timely and well-informed decisions in response to unexpected changes in conditions.

What is a financial framework?

A framework is an essential supporting structure, and we normally hear it in the context of buildings, vehicles, and other objects.

So basically, to have a financial framework means to have a system that guides and supports the structure and operations of all financial matters for your business. 

Financial frameworks are policies, procedures, regulations, and standing orders within your organisation used to make sure that your business is taking care of its money.

That means that through the framework, you’ll be able to track the circulation of your money: your assets, your revenue, your liquidity, your expenditures- all of these, and as your framework is supposedly an organised system, you’ll have no trouble in monitoring the numbers as accurately as possible.

Your financial framework will also keep you in check with your business’ financial goals and whether the status of your finances align with it. A typical financial framework also reflects your strategy in handling finances, and this is best put together after you’ve learned all about financing.

With only these definitions, you can already see why it’s important that every business has one if it wants to succeed. If you don’t have one in place, you can quickly lose control of your finances. And that might kill your business.

A good financial framework will ultimately lead to higher net profit for your business.

The elements to a good financial framework

Having a financial framework is fundamental to any growing business, but it is having a good financial framework that can guarantee that it will be smooth-running.

After starting my own small business years ago and with my experience as a business coach, I’ve seen that there are several elements that you need to consider when putting together an effective framework.

I’ve come up with eight of them so you can learn and make sure that you take them into account if you want to accurately and more easily manage your finances.

Planning

Start with the end in mind.

As with all planning, you should know what you want to achieve by the end of it. How can you justify any of your actions if you don’t know why you’re doing them in the first place?

That leads us to the first of three steps in financial planning: Goal setting.

Set a budget based on the goals that you want to achieve monthly, quarterly, and annually. Remember to set realistic and achievable goals. Being idealistic isn’t a bad trait to have, but when it comes to money matters, it’s more important that you’re pragmatic and practical in goal and budget setting.

Now that you have your goals in mind, the second step is forming your strategy.

Make a personalised game plan that’s easy for you to understand and remember. Make sure that your plan is detailed enough to cover a projection of your savings and investments, risks, limitations, and etc.

The last step is implementing your plan and monitoring your progress.

Controlling

According to the Corporate Finance Institute, financial controls are the procedures, policies, and means by which your business monitors and controls the direction, allocation and uses of its financial resources.

Setting up financial controls helps you in the following aspects:

  • Maintaining your cash flow. Having financial controls in place will help you monitor and plan your cash inflows and outflows better.
  • Managing your resources. Financial resources are at the core of your business’ operational efficiency, so protecting both tangible and intangible assets and resources is important.
  • Improving operational efficiency. With your cash flow and resources properly managed, your business’ overall operational efficiency will also improve.
  • Maximising your profitability. An operationally efficient business will increase productivity and therefore, profitability.
  • Preventing fraud. Financial controls prevents employee fraud, online theft, and other undesirable fraudulent activities.

It also helps you pay bills, invoice your customers on time, give accurate and insightful financial reports, and reduce variation (and needless worry). And ultimately, it helps improve your business’ overall operational efficiency.

Profitability and Margins

A profit margin is one of the most commonly used profitability ratios to gauge the degree to which your business makes money, according to Investopedia. This is measured as a percentage, indicating the amount of cents of profit generator per dollar of sale.

Profit margins point out your business’ financial health, management’s skill, and growth potential  With a properly established baseline for profits and margins, you’ll have better control of your cash flow, variable and fixed costs, and all other expenditure.

Accounting

Accounting is the recording of financial transactions in a business. It includes summarising, analysing, and reporting these transactions over an accounting period. 

It covers sales, purchases, cash flow, credit, and profitability. 

Accounting is essential in decision making (through managerial accounting), cost planning (through cost accounting), and measuring economic performance.

Financial Indicators

Just like performance parameters, Financial Indicators give you a comprehensive overview of the financial situation of your company, whether you are in profit or losing money, and where your business stands in the market.

Performance and financial rewards are also reliant on these indicators.

The five main financial indicators are the following:

  • Growth - this describes the trends in your sales and profits annually
  • Profitability - this depicts how much profit your business is making compared to others in your industry
  • Liquidity - this shows if your company can meet its short term obligations
  • Leverage - this shows if the company is taking advantage of its financial position to operate and grow
  • Activity - this demonstrates how effectively your business manages its assets.

Monitoring all of these indicators will help you in making more informed decisions for your business, whether for managing your assets, boosting sales and marketing, or improving your cash flow and keeping it positive.

Financial Analysis

While most businesses will perform accounting and financial indicator activities, not many take this further and undergo financial analysis exercises.

Investopedia defines financial analysis as the process of evaluating businesses, projects, budgets, and other finance-related transactions to determine their performance and suitability.

These activities include a year-on-year comparative analysis of financial performance, a detailed cash flow analysis, and a ratio analysis.

The outputs from these series of analysis activities determine whether the business is stable, solvent, liquid, or profitable enough for a monetary investment.

Financial analyses give business owners, their investors, and other stakeholders much better insight on the overall company’s financial performance. They also help with future business decisions or reviews of historical successes and trends.

Risk Management

Every business, big or small, faces risks throughout its growth: business risks, non-business risks, and financial risks.

Financial risks are those that relate to how a company can generate cash flow to address debt or other financial obligations.

The Australian government gives helpful tips in managing risks and summarises it into seven steps:

  1. Decide what matters most.
  2. Consult with your stakeholders.
  3. Identify the risks.
  4. Analyse the risks.
  5. Evaluate the risks.
  6. Treat risks to your business.
  7. Commit to reducing risks.

If you follow these steps and document them properly, you’ll be able to establish a risk management system that works. By making risk identification and reduction a priority in your business decisions, you will eliminate or at the very least minimise how these will impact your business.

Mergers and acquisitions

As your company is growing, there may come a time when you’d want to expand your business, explore new markets, or consolidate functions and/or departments. A great way to achieve that is through mergers and acquisitions (M&A).

M&A means one company combines with another. Mergers are a combination of two firms that then form a new legal entity. An acquisition, on the other hand, means one company purchases another and becomes its parent company.

M&A entails a lot of risks. While some progress and succeed, there are others that straight up fail. The latter is because there are a lot of factors to consider when acquiring or merging with another company. 

A great read on the subject is a Forbes article by Richard Harroch, “What You Need To Know About Mergers & Acquisitions: 12 Key Considerations When Selling Your Company”. 

The legal aspect, especially, tends to complicate M&As, but as it is an expansion of business, it definitely has the potential to widen your business' opportunities.

While it seems like it’s a lot to consider, having a financial framework that monitors each of these eight elements will certainly lead your business in the right direction.

By following your framework, your business will be protected from and prepared for any undesirable factor, whether internal or external, that may challenge it. 

Build a business that’s like bamboo: strong and sturdy, but flexible, bending with the wind but never breaking.

It’s a tedious process, I admit that, but if your goal in starting up your business is to succeed and keep increasing your profit, then you ought to start building a detailed and well-thought framework that you will commit to following.

After all, nothing great ever comes easy.

 

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