Why You Need to Create a Financial Framework
Owning and running your own business has a lot of perks, that’s why we kick corporate income to the curb and jump in, but not every aspect of business is thrilling.
You might be an extrovert, people-person who loves sharing your passion with others, or an introvert who loves perfecting a product and refining your offer…but do any of us actually love finance? (apart from seeing dollars in the bank account, obviously).
In my time as a business coach, I’ve met with business owners and entrepreneurs who are amazing at what they do, only they can’t stand admin, or they can’t stand systems or they can’t manage money. They avoid it at all costs and their business suffers for it. Okay, I get it you might not have the head (or heart) for the background business stuff, but it’s essential for solid business growth, scaling, bringing on partners, and just understanding where your business is at and what you need to do to get to the next level.
Am I saying you have to fall in love with everything business? No, but you do need to prioritise your systems and financial framework and put some work in.
Why financial framework is essential to a successful business:
- Solid decision-making and targeting goals
- Prioritising your budget for research, development, growth or expansion
- Capacity to scale when your customers/offering is ready
- You’ll have flexibility in the face of sudden and unexpected change
Previously I’ve written about the importance of maintaining a positive cash flow and have given you tips on how to manage your income and outgoings (without cringing, flinching, or closing your eyes).
With a better understanding of cash flow, revenue, and profit, the next step is to build a sturdy financial framework based on your unique business needs so you know exactly where you stand at any given moment. This gives you absolute flexibility to change gear or step up at a moment’s notice if you need to. A solid financial framework can also boost your confidence in hiring staff, reducing overheads, or putting your profits to the best possible use.
What is a financial framework?
A framework is an essential supporting structure. It works just like the frame of a building, the skeletal structure inside that holds the walls and ceiling in place and enables the building to be completed. A framework is just that: a frame. It doesn’t need to be decorative, creative, or filled in, it’s just there to support everything else.
A financial framework is a system, including policies, procedures, regulations, and standing orders that guide and support the structure and operations of all financial matters for your business.
That means that through the framework, you’ll be able to track the circulation of your money including your:
Once you get your framework sorted it’s much simpler to keep it organised so you’ll have no trouble monitoring the numbers as accurately as possible as you progress.
A good financial framework will ultimately lead to higher net profit for your business.
Your financial framework will also keep you in check with your financial goals and how your finances match up with your targets. You will need to understand the basics of financial handling as the framework also reflects your strategy in managing finances so some financial knowledge or sitting down with your accountant to nut it all out is the best place to begin.
I’ve seen capable and quality businesses struggle, and even fall apart, simply because there was no financial framework outlined. I know that it doesn’t seem critical until things spiral out of control, but by then you might not have enough time to do the work to get it back in line.
The elements of a good financial framework
Taking the time to write out your financial framework is fundamental to any growing business. Through my own self-starting business ups and downs, I’ve come to learn what elements you really can’t live without. This has been put into practice with my business coaching work where I’ve seen the same flaws play out time and again.
These are the eight strategies you can choose from that create an effective financial framework. The more you use, the stronger your financial flexibility and control will be:
Start with the goal you want to reach.
As with all planning, you need to know what you want to achieve by the end of it. It is hard to make solid decisions and justify business purchases if you don’t know what the outcomes will be.
There are three steps to the financial planning stage to tick off so you start your framework with a clear and well-defined end in mind.
- Set your smart goal
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.
- Form 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 current and planned savings and investments, risks, limitations and growth.
- Monitor your progress
This is probably the one step business owners overlook. Making the plan means nothing if you don’t check in and compare your progress against your targets. Monitoring your finances is the key to making adjustments and correcting bad habits.
#2. Financial Controls
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 your business:
- Maintain cash flow
- Acquire and assign resources
- Improve operational efficiency
- Maximise profitability
- Prevent fraud (e.g. employee fraud, online theft)
You’ll also increase your professional ability and brand strength by naturally being able to complete everyday activities easily, like paying bills and invoicing customers on time, accessing accurate and insightful financial reports and reducing variation that can be confusing and outputting to staff, clients, suppliers and customers.
#3. Profit Margins
Out of all the ratios on offer, profit margins are one of the most commonly used profitability ratios to gauge how much money your business is making. This is measured as a percentage, indicating how many cents you get to keep out of every dollar of sale.
While it’s not the only data you need to be assessing it’s the quietest and simplest to work out, as well as being pretty motivating to keep you on target to your goal.
Profit margins point out your:
- Financial health
- Management skills
- Growth potential
With a properly established baseline for profits and margins, you’ll have better control of your cash flow, variable and fixed costs, as well as solid decision-making plans set up around all other expenditures.
Accounting is the record you keep of every financial transaction. As well as listing every money-related movement, accounting includes breaking spending, profits, and assets into easy summaries, analysis, and reports to help identify patterns, flaws, risks, and strengths.
Most of my clients hate this process because it’s tedious. Accountants love it though so this is one job you can delegate to an in-house professional you hire, or outsource to a certified company – just make sure you don’t ignore it. Off your desk isn’t the same as off your shoulders, Make appointments to sit down and discuss your financial accounts including:
- cash flow
Your business accounting is key to financial decision-making, cost planning, and measuring economic performance.
#5. 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 overall market.
The five main financial indicators are:
Growth – As often as needed but especially annual growth comparisons.
Profitability – As well as your own profits you need to be looking at how much profit your business is making compared to others in your industry.
Liquidity – This is financial fitness and how capable you are of meeting short-term obligations.
Leverage – Making a profit doesn’t mean much if you are not using your assets to drive you forward. Leverage helps show you how to take advantage of your financial position and grow.
Activity – Shows how effective your business is at managing assets.
Monitoring these key financial indicators will help you make more informed purchasing decisions as well as provide guidance for how to best manage your assets, boost sales and marketing and improve cash flow.
#6. Financial Analysis
Most businesses will perform accounting and financial indicator activities but not many take this further with financial analysis activities.
Financial analysis is a much deeper evaluation of your business’s projects, budgets, and other finance-related transactions that can determine your performance and suitability.
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 strong and accurate insight into the company’s overall financial performance. They also help with future business decisions or reviews of historical successes and trends.
#7. Risk Management
Every business, big or small, faces risks: 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. I get that you can’t know in advance what challenges you, your industry or the economy might face, but any kind of risk management assessment and plan puts you on the front foot if things go pear-shaped.
Knowing how to prioritise your finances and obligations works best when you have a solid business strategy and financial plan. That way you can hone in on the area of greatest need and attention depending on what risks you are facing. If you have stakeholders this is an important step to bring them in on. They might see risk very differently and identify different areas than you, given they have different goals and perspectives.
In most cases you want to:
- Analyse the risks
- Evaluate the possible directions you can take to overcome them
- Apply action quickly (and calmly)
- Find ways to reduce possible risks where possible
Documenting all the scenarios and solutions carefully will help you establish a risk management system that you can put in place easily and effectively that will steer you clear of the worst of the damage.
#8. 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 or departments. A great way to achieve that is through mergers and acquisitions (M&A).
M&A is where 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 (brand).
M&A entails a lot of risks, not to mention a truckload of legal considerations, complications and paperwork. While some progress and succeed, others straight up fail, famous cases are when a parent company is not willing to share the market with the new acquisition such as the failed merger of Mercedes and Chrysler.
If the glove fits though, a merger or acquisition definitely has the potential to widen your business opportunities.
Having a financial framework keeps your business operations in check and gives you the flexibility to shift quickly and easily, knowing what the stakes are and where you’ll need to give a drake in your budget.
As nice as it would be for businesses just to plod along and continue to make a profit without your attention, the reality is there are multiple curve balls, growth spurts, and downturns ahead. If you wait to assess your finances only when you need to make a change, you’ll probably find that the situation changes faster than your strategies, so you are one step behind.
Will you love doing it? Probably not but understanding your finances it’s a part of loving and nurturing your business to bring it to its full potential.