Cash is the most important asset any firm can have. Scarcity of cash means that a firm will not be able, or has to strain a lot, to pursue its development projects. Creditors, employees, and lenders will have to be paid when their money is due. Unfortunately, for many small, and sometimes large, businesses financial management is not given the required seriousness. It is important to note that the progress of a business highly depends on its financial management, especially for small businesses where the probability of expenses exceeding income is high. It is vital to note that financial management encompasses the whole idea of cash flow management, income maximization, and reduction of expenses.
Importance of Financial Management
Financial management has got several advantages both for small and huge businesses. To begin with, financial management ensures that a business has money to meet its expenses when they are due. On the same note, proper financial management ensures that businesses do not unnecessarily hold up a lot of cash that would have been used to buy inventory. It is also important to note that holding up cash either in the business or with debtors restricts the number of profits a business can make. Therefore, an entrepreneur is expected to find the cash to take care of the present and future bills. Additionally, he or she should ensure that all money owed to the company is collected in good time to avoid cash shortage and stretching of profits (Lasher 132). Similarly, an entrepreneur should be able to pay business bills in time taking into consideration the order of their priority.
Cash flow Management
Arguably, the most important aspect of financial management is the understanding of a business’s cash flow. A proprietor needs to understand the cash flow cycle of his or her business and try as much as possible to reduce it for the financial health of the business. Availability of cash in a business determines the ability of the business to meet its financial obligations (O’Berry 103). It should be noted that cash and profits do not mean the same thing for a business. It is possible for a business that makes good profits to lack money to pay for its expenses. When an organization buys goods for sale, or materials to be used in production, cash reduces. On the other hand, the sale of inventory leads to an increase in the cash balances of the business. Any business should be able to determine the amount of cash balance to be maintained. Consequently, cash budgeting is important for a firm to be able to predict its financial position at any given point in time.
On the same note, a business must be able to accurately predict its sales, cash receipts, cash disbursements, and end-of-month cash balance. Besides ensuring that there is a steady cash inflow to the business, this also ensures that the firm can control its cash outflows. On the same note, cash flow management ensures that a business reduces its borrowing costs and takes advantage of economic order quantity and cash discounts to reduce its spending (Nieuwenhuizen, 43). In other words, good cash flow management ensures the efficient use of cash for the survival of the business.
Managing seasonal Increase in Activity
As a rule of thumb, any business should aspire to increase its income from each venture for a healthy financial position. Small businesses can achieve this by taking advantage of several opportunities, for example, seasonal increases in sales and other income-earning activities. It is important for a business not to diverge from its core activity just because it makes a lot of money from a seasonal opportunity. On the same note, a business should ensure that it has enough cash to purchase extra inventory during peak seasons. The cash to meet the sudden increase in sales can be borrowed from financial institutions or be raised by agreeing with suppliers to delay their payment (Madura 413). It is wrong for a business to stock goods all year round when the goods will be needed just for one season.
Importance of Diversification
On the other hand, a small business will need to address the risk factor as part of its financial management. In this regard, it is helpful for a business to diversify its activities thus spreading business risks. Diversification ensures that a business has several sources of income. On the same note, in case of any downturn in one business activity, a diversified business will always be protected by the other activities. However, an entrepreneur needs to conduct enough research and ensure that the other business activities do not end up wasting cash that could have been used for other purposes.
Treating the Customer as to the Boss
Perhaps, the most important way that a business can increase its income is by treating its customers well. Though the ultimate goal of any business venture is to make money, this can only be achieved if customers are satisfied (Madura 422). Small businesses usually deal with a small number of customers who can easily be known by the entrepreneur on personal grounds. In this regard, treating each customer as if he or she is the only customer of the business will be very essential in customer retention. Retaining customers will ensure that the business makes sales not only to the same customers but also to others who will receive the good message (Lasher 135).
Hiring Employees and Contractors
The reduction of expenses for any business is directly related to an increase in income. To begin with, a small business should be able to determine its expenditure needs at any given moment. For a business whose cycle has seasons, it will be helpful to increase the expenses during peak seasons and reduce them substantially when sales are low. Recurring expenses including employee wages should be reduced as much as possible. Therefore, it will be prudent for a business to take the extra employees needed during peak seasons on contract. This will ensure that during low seasons, the business will not have to pay these employees (Madura 415). On the same note, employing on contract enables a business to avoid statutory expenses and other benefits that permanent employees are given.
Still, on the management of expenses, the business will need to address the question of how much inventory to hold. It should be noted that holding inventory is not a cost-free exercise. Storage costs accumulate whenever inventory is in store. On the same note, inventory ties up cash thus reducing the amount of liquid cash available. Consequently, maintaining low inventory ensures that a firm reduces costs while at the same time it can meet the demand of customers. Similarly, purchases should be made from those suppliers who are efficient in delivery. In this way, the business can be able to arrange for deliveries to be made just when needed to prevent keeping large inventories (Nieuwenhuizen 44). On the same note, small businesses should ensure they have adequate buffer stock to avoid disappointing their customers since this will mean a loss of business.
Relationship between Spending and Taxes
Moreover, the business may structure its spending to take advantage of tax deductions that are associated with some expenses. Entrepreneurs of small businesses must understand the tax structure because this can help them reduce their spending. Firstly, a business can take advantage of the fact that the tax on new investment is zero. Secondly, the business can apply for ax exemption because interest payments on debt used in investments are tax-deductible. On the same note, a business can deduct the wage payments in full to reduce the impact of the marginal tax rate on hiring (O’Berry 97).
Sound cash management is crucial for any business organization. For small businesses, the idea of cash management is quite tricky and in many instances, proprietors find themselves in financial crises. Non-essential outlays have to be avoided. Creditors, lenders, and employees should be paid while at the same time, cash balances must be maintained to take care of any eventualities. Without all this, a business is as good as dead. Consequently, the liquidity of a business is very essential.
Lasher, William. Practical Financial Management. Stanford: Cengage Learning, 2010. Print.
Madura, Jeff. International Financial Management. Stanford: Cengage Learning, 2009. Print.
Nieuwenhuizen, Cecile. Business Management for Entrepreneurs. Lansdowne: Juta and Company Ltd, 2009. Print.
O’Berry, Denise. Small Business Cash Flow: Strategies for making Your Business a Financial Success. Hoboken: John Wiley & Sons, 2010. Print.