An entrepreneur has a lot of factors to take care of when managing his/her enterprise. But among them, one of the most important is assessing the financial stability of the enterprise and ensuring that appropriate planning has been done with respect to finances. This is true, especially in the nascent stages of the enterprise, where aspects such as seasonality of demand, cash flow issues, introductory and steady-state pricing, and investment in the business are of paramount importance. Having an enterprise in any sector (social or otherwise) requires you to set up the enterprise correctly and look at legal and contractual obligations as well. In one of the previous blogs, we had covered the topic of funding for social entrepreneurs (for-profit or non-profit) and addressed questions social entrepreneurs have, or should have, and pointed to typical fund-raising pitfalls and best practices. (Fund Raising for Social Entrepreneurs). This blog aims to give clarity to budding entrepreneurs with respect to managing the financial aspects of their enterprise.
1. Getting familiar with financial language and numbers
Getting familiar with numbers is very important to understand the financial position of your enterprise. It doesn’t mean you have to study Accounting/Finance in depth, but you should know how to evaluate your business based on financial statements and certain key financial concepts such as Gross Margin, EBITDA Margin, Net Margin, Working Capital Cycle, Capital Expenditure, etc. These concepts are very critical to understanding and efficiently operating your enterprise. It will also make you confident about your business and help you present your financial position confidently in meetings with board members, investors or other stakeholders.
2. Create budgets and track them
Budget sets out the quantitative goals for your enterprise. Creating a budget at the start of each year and tracking your actual performance against the budget at regular intervals is crucial. This gives you inputs on the areas you are doing well and the areas that need improvement. Budgeting exercise typically starts with the sales budget/plan for the year and then trickles down to other financial aspects such as Cost of Goods Sold/Services (COGS), Salaries, General and Admin expenses (G&A), Capital Expenditure, Working Capital, etc.
Depending on the size of operations of your enterprise, you can create and track a detailed budget for each of the financial aspects as mentioned above.
3. Understand working capital
Working capital means the capital essential to run your business on a day-to-day basis.
There are 4 components of working capital – Cash and Cash equivalents, Inventory, Receivables and Payables.
Working capital cycle, or cash conversion cycle, is the cycle required for your enterprise to convert Input Cash to Output Cash. Working capital cycles differ by each industry. A shorter working capital cycle is better for your enterprise as it depicts the strength of your enterprise to convert the Input Cash to Output Cash quicker.
Cash conversion cycle
Following are a few important aspects to keep in mind to manage working capital efficiently:
- Payables – Negotiate and agree on good terms with your suppliers
- Receivables – Send invoices on time and follow up for timely collection
- Inventory – You need to optimise the levels of inventory, because it is money invested in your business. A very high level of inventory means too much money is invested in the business. On the contrary, low inventory means you may not be able to cater to customers in case of sudden increase in demand. Maintaining optimum inventory levels becomes more complicated when you have a long manufacturing cycle.
You should be cautious about the working capital cycles in case of high growth stage of your enterprise. High growth phase puts pressure on the working capital needs. You need to plan your working capital needs in advance so that you do not miss out on the increased business.
Working capital management poses a unique challenge in seasonal/cyclical industries/enterprises such as Agriculture, Education, etc. Working capital sways from highs to lows in these sectors during high and low seasons. You need to plan the working capital carefully in case you operate in a seasonal/cyclical industry.
4. Compliance management
Compliance management is very important for any organisation. You should focus on compliances for your organisation from the very beginning. Many times, compliance aspects are overlooked due to lack of knowledge and understanding. Being compliant with the applicable laws not only saves you costs (in the form of interest on delayed payments, penalties, etc.), but also helps you build the reputation of your organisation in the eyes of the regulators, investors, and other stakeholders.
While the points mentioned above are not an exhaustive list, we feel that they should cover the basics needed by your enterprise to prosper. Adding stability and predictability to your enterprise is of paramount importance as well as safeguarding yourself from legal and financial pitfalls.
Mentioned below are some links to useful reference material about the topics covered in this blog:
- Financial Terminology: 20 Financial Terms to Know | HBS Online
- Key financial terms | business.gov.au
About the Authors:
Mr. ShekharJadhav has over 20 years of multi-disciplinary experience in Corporate Finance, Software Development and Consulting during his stints with Virgo Valves, Oracle India, Ernst & Young and PricewaterhouseCoopers. Shekhar runs a multi-family office based in Pune, managing investments across multiple asset classes including Public Markets and direct Private Equity/Venture investments. Shekhar is a gold medallist Chartered Accountant. He is also a mentor at Social Innovation Lab, Pune International Centre.
Mr. Amit Bhargava
Mr. Amit Bhargava is AVP at Birlasoft. He is an accomplished professional with over 18 years’ experience in strategy, sales operations, IT consulting, business analysis, stakeholder management, and programme and project management. He has extensive experience in business analysis and requirement elicitation/detailing for new IT applications and product feature development across conventional SDLC projects and Agile projects. He has been recognised for Excellence in Selling, Thought Leadership, and Six Sigma Green Belt Certification. Amit is a mentor at Social Innovation Lab, Pune International Centre.