Show me your financials, and I’ll show you what you are: financial governance basics for SMEs

At Assurety, one of our key services is conducting financial due diligence. Businesses engage us to ‘look under the hood’ of potential acquisitions to understand and validate their financial position.

In the financial due diligence process, the questions we ask ourselves are:

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  • Do the financials match the narrative Management is telling us?
  • Can we validate Management’s assertions with data?
  • What are the commercial risks of this business and how can they be mitigated?

What I enjoy most about the due diligence process is the art of deconstruction. Like stripping an old, rotting house to its frame, it is satisfying to pick apart a business to its fundamental elements. Identifying structural strengths, weaknesses and suggesting remedies for treatment.

Collectively, we’ve analysed hundreds of organisations of all shapes and sizes. From high performing businesses to ones that struggle to break even.

After reviewing these businesses through an analytical lens, there are identifiable characteristics that separate an average performing business to a great one. 

Management often leaves clues. Our craft is knowing which clues to investigate and assess what we can learn from them.

The most compelling set of clues is the hygiene of the company’s finances. The typical leading indicators of a poorly run business are as follows:

  • an unstructured chart of accounts
  • month old bank reconciliations
  • Overdue Superannuation balances
  • Unlodged BAS
  • Suspense balances 
  • Debtors that are 6+ months old

Outsiders perceive these as somewhat ‘petty’ elements. I get it, I am an accountant, after all…

Yet, it’s in your best interest to understand why these basics are important.

Sound financial hygiene is not a ‘nice to have’ – it is a legal obligation

As a company Director, there are duties you must follow and abide by. These duties are in fact, legally imposed by the Corporations Act.

These duties include:

  • Your company must keep adequate financial records to correctly record and explain transactions and the company’s financial position and performance.
  • you are properly informed about the financial position of the company and ensuring the company doesn’t trade if it is insolvent.

In other words, every company Director has the legal responsibility to have an understanding of their financial position. 

Experience has taught me that there is a direct correlation to poor financial hygiene and the risk of insolvency. With cashflow management as a leading cause of business failure, improving your financial management and literacy is a journey worth embarking on.

So where do you start?

Financial Governance tips for company Directors

1. Start with regular and accurate bookkeeping

Most business owners view bookkeeping as a compliance-driven activity. It is often perceived as a low-value, commoditised administrative function.

This is a deadly misconception.

The reality is that Bookkeeping is the most valuable layer of your business as it underpins the finance function of your organisation.

The value of bookkeeping is the generation of financial data, used to aid your decision-making process. The ability to generate reports like a profit and loss, balance sheet and cashflow statement can help you understand the financial performance of your business, and guide your strategic decisions.

Bookkeeping should be maintained at least on a weekly basis, with the target of closing month-end within 14 days. This allows appropriate time to measure your actual results against the budget and set targets for the following month.

2. Set a 12-month budget

I am going out on a limb and estimating that 95% of small business owners do not have a budget. If you are a freelancer or sole trader, it’s likely that you are small enough to have a pulse over your operations. In this instance, you don’t need to get too sophisticated with budgeting.

However, once you grow beyond say five employees, relying on gut instinct just won’t cut it. You will need external reporting and systems to allow visibility over your operations and cashflow – used to augment your decision-making process.

Beyond visibility, the value of developing a budget is in the process. It will help you understand the drivers of your business.

For example, in order to budget your revenue, you will need to think in number of leads, average sale value, conversion rate.

Revenue equation:

Number of leads X conversion rate % X average sales value = Revenue

By getting granular with the drivers of your business, you can start to manage and measure your daily and weekly activity. With a budget, you can plan your cashflow and be proactive in your decision making – as opposed to making decisions based on gut feel.

3. Set monthly board meetings 

Directors must ensure that they are regularly informed of their financial position. Relying on the financial statements produced at year end by your tax accountant is not enough. It’s old information and mostly useless. 

We recommend you review the financial performance of your company on a monthly basis. A meeting should be set each month with management to review the organisation’s financial performance. 

The reports to review, as a minimum, are as follows:

  • Compare current month profit and loss against budget;
  • Compare year-to-date profit and loss against budget;
  • Cashflow report for the current month, with rolling forecast for next month; and
  • Accounts receivable listing.

You can get pretty sexy with your board reporting. Click here to see a few examples.

Each meeting should have an agenda to ensure that all bases are covered and the time is respected. Document the actions that fall from the discussions and delegate them to be actioned prior to the next meeting.

It doesn’t matter how the agenda and actions are documented – as long as they’re easily actionable and visible across your team. We recommend the use of governance software like ProcessPA

Conclusion

Setting time aside each month to take a step back and assess how things are doing can you help escape tunnel vision of being stuck in the business.

Following this simple process will not only help you be accountable to your goals, but help you make smarter business decisions.