“Financial literacy is critical if we are leading a business as an owner or a business manager,” BDO Partner of Business Services, Craig Mitchell, says.

“The key is understanding how money is made and spent in your business, to make better financial decisions. It’s about investing, spending, new markets, breakeven points, when you should pull the pin on something that isn’t working or when you should double down on something that is.”

You don’t need to be an accountant to understand the foundations of financial literacy, but Craig says knowing accounting basics and being able to use financial terms competently and confidently, will be very beneficial.

“Being able to talk in the language of finance really helps to drive the conversations you may need to have with your chief financial officer, finance manager, bank manager, accountant or bookkeeper,” he says.

“This will also help you when it comes to interpreting your financial statements, which is really crucial in making decisions.”

Profit and loss statements

A profit and loss statement details the performance of your business by measuring the income derived and the expenses incurred during a specific period of time. It includes income, costs of goods sold (COGS), gross profit, operating expenses, non-operating expenses, operating profit, non-operating profit, and net profit.

“Most business owners tend to look at the top line (sales) and the bottom line (net profit), but the lines in the middle are just as important,” Craig says.

In particular, he emphasises the importance of understanding COGS, for making pricing decisions and growth profitability.

“COGS are costs that you must incur as a business in order to produce your goods or services,” he says. “Generally, there is a clear relationship between COGS and our income. The more you sell, the more you will have to spend on COGS.

“You want to be able to see that relationship and analyse it for strategic decision making. If your COGS is flat or all over the place, if it has no relationship to your income, you need to dive in for a deeper look to re-steer the ship.”

Craig recommends reviewing your profit and loss statement monthly.

“If you review too frequently, the data you get might not be great,” he explains. “For example, if you pay wages fortnightly, in week one you have no wage expenses and in week two you have lots of wage expenses, so weekly reviews will distort your perception of your business.

“Monthly reviews will provide you with enough information within the time frame to base decisions off.”

Cash flow

Cash flow management is critical to success. You can have a profitable business, but that doesn’t necessarily mean you have cash in your business.

“Cash flow is the oxygen in your business,” Craig says. “It’s the foundation for your business success, particularly as you are growing.

“Cash flow helps to sustain growth, helps to add value to your business and helps you plan for the future of your business.

“When you need to improve your cash flow position, there are seven levers you can pull to positively influence your cash flow.”

Levers one to three: Increase cash coming in

1. Pricing

Craig says setting the right price for your products and services will improve your cash position and help you to maximise profits.

“An increase in price, if it doesn’t impact your customer demand, will have a positive impact on your cash flow,” he says. “You can do this through simply increasing prices, or by making improvements to your product and increasing the value you deliver to your customers, so they’re willing to pay higher prices.”

2. Volume

To increase the volume of your sales and  generate greater income, Craig suggests:

• Increasing the range or number of products or services you offer
• Discounting or having a promotional sale to attract new customers (or encouraging repeat purchases)
• Selling into new markets
• Improving your sales process and customer conversion rate.

3. Accounts receivable

Always remember you are not a bank for your customers.

“Collecting payments from your customers as quickly as possible will improve your cash position,” Craig says. “Establish clear credit policies and carry out credit checks before setting up accounts. Collecting what is owed to you should be a priority.”

Levers four to seven: Decrease cash going out

4. Expense

Reducing overheads will immediately free up cash. Craig suggests scrutinising your operating expenses as a first step.

“If cash flow is tight you need to tighten up operational spending in your business,” he says. “To do this, it’s important to review your profit and loss and cash flow regularly. All you need to do is look for a potential one per cent change in overheads. Identifying and reducing non-essential expenses is also a great first step.”

5. Assets

Under-utilised or unnecessary assets tie up cash that could be put to better use in your business.

“Consider whether leasing some assets is a better option,” he says. “Sell assets you no longer need and regularly review your balance sheet to understand your asset position.”

6. Human Resources

Staff costs are a significant expense for many businesses, but cutting costs here isn’t necessarily about cutting staff.

“Choosing the right staff, keeping the right amount of people on and reducing staff turnover will have a positive effect on your cash flow position,” Craig says.

“You also should consider how you can increase productivity with the staff you have.”

7. Inventory

Craig says maintaining the right levels of the right inventory is essential.

“Forecast your customers’ needs and buy and ship inventory as close as possible to the time of sale,” he says.

Knowing your numbers is no easy task. It takes time to learn and comprehend, but it is an investment that all business owners need to make.