Here, we examine the two pillars of financial management: profitability and liquidity.
Last issue we looked at the reasons pest management operations can fail, and we soon saw a common thread — they all centred on cash flow. The problems identified all had something to do with financial management. They constituted what could be called the ‘mortal sins’ of financial management and proved an inescapable conclusion — the real cause of the very high rates of failure in most industries, including the pest industry, is poor financial management.
Pest management business owners and managers are typically only experienced and trained in, at most, three functional areas: how to sell, technical product knowledge and processes employed.
It’s pretty clear that an additional knowledge set needs to be ramped up in the industry, and that’s financial management. The easy way to fix this anomaly is to dump it all in the external accountant’s lap or give it to the internal bookkeeper or the administration assistant to worry about. But for those pest management businesses doing well, it’s the owners or managers themselves that have a firm grasp of the principles of financial management and are actively applying them to their own situation.
The ultimate objective of financial management should be to maximise the financial wealth of the business owner or shareholders. What does this entail? What are the objectives? What decisions does it involve? What tools and techniques need to be employed?
The general goal of successful financial management can be viewed in terms of two much more specific objectives. The first of these is the profitability objective, which is concerned with managing the flow of sales revenues into, and operating expenses out of, the pest management operation. The second is the liquidity objective, which is concerned with managing the flow of cash into and out of the business.
The objective of every successful business is to maximise profitability by ensuring that every dollar invested by the owner or shareholders is put to its most efficient use; that is, the use which ensures the highest return. The basic rule of financial management is profits do not happen, they are planned for and worked towards.
Profitability management is concerned with maintaining or increasing a pest management business earnings through attention to:
- Cost control
- Pricing Policy
- Sales volume
- Inventory and debtor management, and
- Capital expenditure.
A second objective is to ensure successful liquidity by ensuring that, as a minimum, a pest management operation is always able to meet its obligations such as; wages, creditors, loan repayments, BAS and other tax obligations; in cash, as and when they fall due (cash means funds in the bank).
Ideally, the owner or manager wants to avoid any damage at all to their credit rating, due to a temporary inability to meet obligations, by:
- Anticipating cash shortages
- Maintaining the confidence of creditors, and
- Pre-arranging finance to cover cash shortages.
Conversely, the owner or manager should minimise idle cash balances that could be profitably invested elsewhere, for example, paying suppliers quickly to pick up early settlement discounts where available.
The underlying reason for needing two objectives for good financial management is that profit does not equal cash flow. Why? Because sales revenues do not equal cash flow; products and services are usually invoiced out; and not all cash in flows result from sales, for example, cash provided via a loan from a bank or new capital contributed by owners or shareholders.
And operating expenses do not equal cash out flows. Why? Because most products and services provided to the operation are received on credit; not all cash out flows result from expenses incurred, for example, repayment of a loan to a bank, purchase of equipment or dividends to owner or shareholders; and not all expenses involve a cash flow, for example, depreciation of equipment and bad debts, etc.
Over the whole life of a successful pest management business you would expect eventually that profit and cash flow would be equal, but in any period, they can be different for the reasons given.
It is the task of the owner or manager to ensure that by proper planning and control, one follows the other smoothly as the operation moves from one period to the next. That is the objective of good financial management.
Peter Cox, Peter M Cox & Associates