Today, everyone is eager to step into the entrepreneurship world and become financially independent. Fortunately, starting a business has become straightforward in this savvy world but running it is no fun and games. It demands a lot of effort, time, resources, and, most importantly, money. Whether you are recruiting people or marketing a business – entrepreneurs need hefty capital to run the show. Overseeing finances and allocating budgets to every department seems effortless until this responsibility comes down on your shoulders.
From funding routine expenses, buying equipment, to paying dividends – effective financial management creates a roadmap to success. Therefore, a company’s financial management needs extra attention and vigilance. In addition to maintaining records, you have to calculate annual profits, keep up with tax obligations, and manage expenses. Simultaneously, you have to ensure compliance with regulatory bodies and accounting standards.
At times, businesses also encounter liquidity problems and funding crises due to the unavailability of cash. Since financial challenges are a part of business, you have to learn how to manage them rather than giving up. Understand the potential pitfalls, business pain points, and manage finances carefully. If you are unaware of the world of finance, have a look below. Here we are unfolding five challenges of financial management.
Sometimes, companies manage finances at their convenience. They record expenses whenever they want to, combine business and personal income, and don’t account for reporting dates. Becoming an entrepreneur doesn’t mean you can play by your rules. In the finance world, you have to follow a set of accounting standards to keep your finances on track. The regulatory bodies have issued international financial reporting standards (IFRS) to streamline the financial structure.
These international financial management protocols maintain decorum, ensuring every company is on the same page. It gives a standard structure to financial statements, where companies fill in every detail – sales, income, expenses, etc. Likewise, IFRS assists with tax obligations. They outline the tax calculation procedure while explaining how to adjust tax deductibles in the financial statements.
Moreover, these standards ensure accuracy and relevancy. For instance, if you incurred a loss in 2014, you won’t add it to the 2020s financial statement. Similarly, if your financial reporting date is 30th December, you have to stick to it till your company exists.
Even though entrepreneurs invest loads of money as initial capital, companies need a continuous flow of funds to keep running. As a result, they consider lending from external sources. Bank loans seem like a handy option but coughing up money on interest with repayments is not a piece of cake. Alongside taking a considerable chunk from profits, it leaves companies at the risk of bankruptcy.
Usually, businesses determine their repayment capability by looking at future projections, but it still doesn’t account for uncertainties. For instance, companies who took loans based on 2020s projections are on the verge of shutting down due to the economic turndown. Thus, the risk element is always present in external financing. However, companies who are unwilling to put everything at stake opt for an initial public offering (IPO). It means they raise money in exchange for ownership in the company.
It is up to you how much ownership you are willing to share since it could be 2% or 20%. Are you wondering why people buy shares? Since investors have some share of ownership, they also have over the company’s profit. Therefore, you have to take out a chunk from profits and pay out dividends to return on their investment. And in the case of profits drop-down, paying dividends becomes a significant financial challenge because you won’t have enough money to incur future expenses.
Is your company always short on cash? Despite skyrocketing sales and profits, businesses face overwhelming liquidity problems as current assets are lower than liabilities. In other words, the company is not liquid enough to pay its creditors and other payable. The leading cause of this problem is the overreliance on credit sales. It is great to give customers some leverage over the payment terms, but not for the sake of your business profitability. Because if they don’t pay timely, unavailability of funds can halt the entire business operations.
You can’t pay back suppliers, settle utility bills, or incur any other business expense. At the same time, insufficient liquidity outlines weak financial performance, leaving a wrong impression on shareholders. In case your current ratio falls below 0.5, investors will start selling their shares. Therefore, companies have to address this issue at their earliest possible. You can either set flexible payment terms with the suppliers, set a limit on credit sales, and utilize cash sales to subsidize daily expenses.
Although running a business is all about taking risks, it is never wise to put all eggs in one basket. Instead of reinvesting all profits into the business, owners look for other lucrative opportunities. And these investment activities open doors to more financial challenges and risks. You might think of crawling into the stock markets to invest in other companies. In addition to your company, you will have to keep track of other company’s whereabouts.
Similarly, some entrepreneurs explore the financial securities market. Bonds, commercial papers, and T-bills can offer lucrative returns, but this industry is highly volatile and uncertain. Besides this, investing in plants and machinery poses another financial challenge. You have to assess whether bringing new machinery will increase profits or not. Feel free to conduct a cost-benefit analysis to determine whether the benefits outweigh the costs or not.
The business environment is complex, and calculating profits takes more than subtracting costs from sales. As a result, finance managers draft financial statements to pen down every business detail. The income statement gives an insight into increasing raw material costs, expenses, and overall business profits. Similarly, balance sheets weigh liabilities with assets to assess the company’s financial health. A slight mistake in anywhere unbalances the entire statements, calling out for an audit.
Alongside drafting these statements, it is crucial to evaluate them adequately. Financial analysis requires performance metrics – inventory-turnover ratio, debt coverage ratio, solvency measures, etc. Analyzing these metrics requires an eye for detail and in-depth financial knowledge because there are no hard and fast rules. For some companies, a 10% profit ratio might be too low, whereas companies with hefty loans and 10% profit reflect a positive image.
Believe it or not, financial challenges are inevitable because businesses encounter money-related problems at some point. After all, the dynamic and uncertain market conditions put a lot of pressure on the financial systems. Managers have initiated cost-cutting methods, report financial statements, assess liquidity, and protect themselves from solvency. Fortunately, one can combat all these challenges with efficient management practices.