Your business is a combination of different processes coming together. The better you get these processes to work together the better your business will perform. Business is not a micro-organism that can be left alone on its own to simply multiply, expand and evolve on its own. Business is something that has to be nurtured, worked on, and improved on. Controlling these processes means you can control your business and have predictable outputs. It is as simple as controlling the controllable.
You will be surprised how easy it is to control your business once you have broken it down into manageable sections and implement controls and procedures to automate the running of your business.
Without exception, each and every business has to obtain funding, invest such funding into assets which in turn generates income and corresponding expenses. For ease of reference, these can be referred to as the debt cycle, asset cycle and revenue cycle.
The Debt Cycle
Debt consists mainly of owners equity or 3rd party debt funding. Both these have a cost associated with it. The cost relating to 3rd party debt funding is referred to as interest or finance charges where ass the cost associated with equity is referred to as the cost of equity.
Corporates refer to the average cost of their debt as the weighted average cost of capital and include on average all the costs associated with the various funding utilized by them.
We will however not focus too much on the technicalities but rather ensure that you understand your choices and the manner in which you finance your business has a long-term and potentially severe impact on your business, cash flow as well as your company and personal risk profile.
The most common form of finance relates to deft finance obtained from a financial institution. Such debt is usually based on a predetermined term at a fixed or variable interest rate. The terms are highly dependent on the type of asset you acquire as well as the risk profile whereas the interest rate is an indication of the risk profile as assessed by the financial institution.
The most expensive debt relates to short-term overdraft funding secured by your customer book whereas less expensive debt relates to finance obtained back by long-term fixed unencumbered assets.
Debt funding utilized correctly is a very powerful tool. It allows for leveraging however one has to be very cautious and take into account where you are in your business lifecycle.
- Do I need 3rd party finance now?
- Can I fund my business internally?
- Can I make repayments as and when due?
- Do I need to negotiate my finance charges and interest rate?
- Do I have to sign surety and security for the debt which I am receiving from the financier.
The Asset Cycle
Assets are acquired based either on equity or debt funding obtained. This is referred to as employing your capital. The type of assets a business has to acquire depends wholly on the type of business module. Some businesses rely heavily on a large asset base where other businesses are less asset-intensive. Comparing a transport and logistics service provider to an advisory consultant results in a totally different asset base requirement.
Assets are generally referred to as property, plant, and equipment and classified as land and buildings, plant, equipment, motor vehicles, computer equipment, and much more. The asset category is dependent on the type of asset also resulting in whether the asset is to be utilized over the long or short term.
The revenue or income generated from an asset is referred to as Return on Invested Capital and indicates the effectiveness of generating returns especially compared to other entities in the same market.
Companies requiring little or no investment in assets such as consulting and advisory spend most of their money on human resources. Unfortunately, the regulators and accounting standards have not yet come up with a useful solution to indicate the intrinsic value of a human workforce. As it stands such entities have to expense this cost not being able to show it on their balance sheet.
- Which assets do I really need to generate income?
- Can I buy second hand or does it have to be new?
- How long is my investment cycle, in other words if I invest in this asset when will it yield returns?
The Working Capital Cycle
The working capital cycle takes into account your customers, inventory, bank balances, and short-term funding such as suppliers. The length of this cycle has a direct impact on the effectiveness of a business to convert its short-term assets into cash and subsequently pay its suppliers.
The longer your cash is tied up in inventory and customer accounts the more you lose on earning interest on money that should be in your bank accounts (opportunity cost) as well as potentially incurring penalties on late supplier payment or worse having to obtain an overdraft facility with a financial institution at expensive funding rates.
The working capital cycle is the nuts and bolts of your operations and requires dedicated attention to ensure it is run as efficiently as possible. The savvy business owner knows his business from the ground up and focuses his time on efficiencies and processes ensuring the working capital cycle is shorted and streamlined.
Aspirational (forward) thinking:
- How long is my working capital cycle?
- How can I improve manufacturing and limit time and material losses?
- Have I negotiated more favorable terms with my customers or suppliers?
The Revenue and Expenditure Cycle
The type of revenue and associated expenditure relate to the type of business you are managing. Revenue consist either of trading income or passive holding income such as dividends whereas the corresponding expenditure is usually classified as variable and directly related to the generating or the income compared to fixed overheads which are fixed and not directly related to the income generated. This is commonly referred to as ‘cost of sales’ and administrative expenses.
- Do I have to incur this expense now?
- Do I have to sing a long term fixed agreement or can I rather incur the expense ad-hoc
As part of managing these cycles, we guide you through various processes which you should think about, consider and actively change on your journey to become free.