Understanding finance… what managers SHOULD and Directors MUST know

“We’re making a profit, so I guess everything must be okay”……..Are you sure?

Why understanding a bit about finance can help your business to thrive

(and how it may even KEEP YOU OUT OF JAIL!)

For many years I’ve used an experiential business simulation to help non-financial supervisors, managers and directors to improve their business acumen and to get a better understanding of what the financial information in their companies can tell them.

I’m delighted to be given the opportunity to plug some of the knowledge gaps that my clients have recognised for themselves that are becoming even more important in an increasingly difficult trading environment.

My big worry is always…….”What about the business people who make no attempt to develop any financial competence?”

It is easy to see why some decide to avoid the numbers:

• “We’ve got the finance team for that”.
• “I only influence a small area of the company’s profit and loss account, I don’t need to see the big picture, balance sheet or cash flow information”.
• “The information layout is just gobbledygook, I was never good with numbers and I’m going to embarrass myself”.

At best, these people are missing out on becoming better informed and able to include commercial judgement into their operational decisions.

At worst, if people are operating at director level, sticking their head in the sand could leave them in a hugely exposed personal/legal position if the company ends up in liquidation. Ignorance of the numbers is never an acceptable defence.  Potential civil and criminal penalties can and do arise in these situations.

Let us consider the positive aspects of improved business decision making and the defensive self-protection requirements separately.

HOW FINANCIAL AWARENESS CAN HELP IN OPERATIONAL DECISION MAKING

Almost everything that happens in a business will work its way into the financial results. Unfortunately, often the accountants only find out about some key operational decisions after the event.  If managers can gain a basic understanding of the financial reports and the importance of the few critical things that need to be focused upon several benefits can accrue.  A commonality of language and shared areas of attention will aid communications, improve synergies between departments and lead to joined up management thinking.

For example:

• If everybody is aware of the importance of working capital (how money flows through or sticks in a business) operational managers can consider if they are helping or damaging the business in this area:
  • Sales teams could avoid agreeing long payment terms to win work.
  • Buying departments may focus on getting longer to pay for supplies.
  • Stores and production managers may look to have less inventory on the shelves or in manufacturing processes and focus hard on reducing wastage. Buyers meanwhile may explore suppliers holding material until it is needed, with the business only getting billed when it is actually used.
  • Project managers will realise how important it is to raise invoices without any delays.
• An understanding of how cash shortages kill businesses quicker than anything else would possibly:
  • Encourage client facing staff to help out with credit control issues, either with debt collection or spotting customers who are having problems paying.
  • Make people aware how dangerous unbudgeted spending can be.
  • Better acceptance of tight control of spending timings on capital expenditure /investment/ expansion projects.
• A good grasp of the nature of costs and the minimum required profit margins could lead to:
  • Sales teams only bringing in work at high enough prices. Bonuses linked to profitable sales, not to any sales.
  • Better liaison between sales teams and the production department to ensure resources and schedules are focused on higher profitability work to avoid becoming busy fools making no money.
  • An understanding of the activity levels needed to achieve more than a breakeven situation.
  • Improved budgeting accuracy and ongoing control.

KNOWLEDGE TO PROTECT YOUR PERSONAL FUNDS AND KEEP YOU OUT OF JAIL

When you are lucky enough get appointed to the company’s board of Directors you will naturally enjoy warm, fuzzy feelings of success.  So you should, but you need to be aware of some downsides to guard against.

If a company fails, then the directors of the limited company will not normally be held liable for the debts of the company. However, in certain circumstances, the courts can deem one or more directors liable for the company’s debts.

The directors are held jointly and severally liable (i.e. all responsible regardless of your specific expert role in the business) and have a statutory duty to act in the best interests of the company’s creditors if it becomes insolvent.  The sort of actions directors might take, which evidences they are NOT ACTING IN THE BEST INTERESTS OF THE CREDITORS include:

• Continue to pay shareholder dividends while the company is insolvent
• Continue trading with no intention of repaying creditors
• Attempting to repay debts through fraudulent means such as dishonest transactions that cannot be fulfilled
• Selling assets for less than their market value
• Repaying some creditors but not others.

In these situations, directors open themselves up to becoming personally liable for company debts in addition to possible civil and criminal charges.

When a company goes into liquidation, a liquidator will be checking the directors’ behaviour in the period prior to the insolvency to check they have not been guilty of WRONGFUL TRADING or worse FRAUDULENT TRADING (which carries a potential 10-year prison sentence).

The definition of wrongful trading is when directors continue to trade past the point where they:

• “knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation”; and
• they did not take “every step with a view to minimising the potential loss to the company’s creditors”.

HEREIN LIES THE RISK. if any director does not make themselves financially aware enough will they be able to SPOT THAT IT IS UNLIKELY TO BE ABLE TO AVOID INSOLVENCY.

If a non-finance director at least understands the information a balance sheet can give them about future debts against money coming in, they can perhaps challenge their finance colleagues as to whether there are any problems.

A bit more knowledge will help them dig into cash flow forecasts for more detail about if, and when, the company is likely to run out of cash and what remedial steps are to be undertaken.

Additional personal risks arise if any director has signed a personal guarantee for company debts.  These are common in smaller companies and leave the director with extra problems in addition to the wrongful trading scenario described above.

Thus, it is vital that all directors give themselves, at least a fighting chance of understanding when their business is in trouble as early as possible, to take steps to mitigate the damage as much as possible.

DON’T JUST BLINDLY RELY ON YOUR FINANCE GUYS!

UNDERSTAND, CHECK AND CHALLENGE!

If your management team need help in understanding their responsibilities with regards to the financial accounts, and in making better financial decisions, then I am always here to help, either through our two-day business simulation course or through coaching and consultancy assistance. KEITH WILSON of Pearl Onion Training.  Contact keith@pearlonion.co.uk , 01467 681404 or get more information at http://pearlonion.co.uk/