Starting a new business is always exciting for anyone, but it is also challenging. But like any new thing, the excitement fades away, the honeymoon phase ends but the challenges remain. This is why having a firm foundation is quintessential to overcome challenges down the road.
The accounting & financial activities of businesses, especially small ones, are usually thrown to the bottom of the to-do list as compared to other “important” activities such as sales. This means without a continuous organized record, an entrepreneur has no idea where the business stands financially. Thus, causing repercussions that can’t be reversed or solved.
‘Building a firm foundation’ will be a series which discusses everything that makes up for a firm business foundation.
This series begins with talking about the importance of proper accounting & finance for every business, whether small or big. So, let’s begin!
When talking about new projects, companies must take a holistic approach in managing the process.
Accounting helps in assimilating data in an organised manner so that relevant reports can be generated for decision making. Finance functions use this organized data so as to generate reports that are relevant, concise and informative.
All new projects require a proper situational analysis. Proper financial records aid a company to assess what its strengths and weakness are, and aids it to decide whether it goes forward, changes certain processes or drops the project.
Understanding accounting & finance is a very important aspect and contributor to the success of the project. This is because financial records help the company determine whether it has the required resources and capabilities for the business venture. Proper financial statements also provide an assessment of a company’s resources for capital investment, manpower and operational costs.
Company funds are always a significant amount no matter what the size of the company might be. Therefore, it is necessary for businesses to account how and where the company funds are being used. As a non-person entity, an organisation needs to exercise effective control over funds through the use of human resources and technology. The finance function in particular helps in this process by formulating reports that aid an organization to employ qualified personnel fit for the job & worth the money, to apply appropriate strategies and to purchase the right technology. Finance and accounting oversee the source and application of all company funds by ensuring proper accounting through the use of relevant internal controls. Internal accounting and finance controls safeguard the organization from potential risk of errors, omissions and frauds.
Let’s get one thing clear. A healthy bank balance or a healthy net contribution line of a company DOES NOT necessarily indicate a healthy financial position. Investopedia (2004) gives a very good example to explain this,
“say a manufacturing company is experiencing low product demand and therefore decides to sell off half its factory equipment at liquidation prices. It will receive cash from the buyer for the used equipment, but the manufacturing company is definitely losing money on the sale: it would prefer to use the equipment to manufacture products and earn an operating profit. But since it cannot, the next best option is to sell off the equipment at prices much lower than the company paid for it. In the year that it sold the equipment, the company would end up with a strong positive cash flow, but its current and future earnings potential would be fairly bleak. Because cash flow can be positive while profitability is negative, investors should analyse income statements as well as cash flow statements, not just one or the other.”
A healthy balance sheet reports a healthy ratio of its various elements, and finance & accounting helps in explaining the various ratios and also produces an analysis of the results. Finance & accounting helps in assessing the profitability of resources by measuring the cost of employing that resource against the revenue generated by that resource. Finance particularly helps in determining the profitability of any business unit by the department/cost centre/job and also generates a total company profitability report, which in turn helps in assessing whether a company is healthy or not.
Business decisions aren’t something that can be taken just simply based on a gut feeling or impulsively, as every decision has the potential to shipwreck a company. Therefore, a sound business decision is one that is based on reliable, accurate data which is something accounting and finance provides. Finance and accounting helps in gathering data and putting them in a systematic manner so that the information generated is accurate, makes sense and is useful for decision making.
Since data is captured in an organised manner, data can be arranged on a timeline to give a historical analysis of the past trends. Past trends in turn can be used to forecast future trends.
Also in case of a bad decision taken, finance & accounting helps to identify the source of the issue i.e. how resources have been used ineffectively, so that corrective action can be taken.
Another reason why sound accounting and finance is necessary for a company, is because, accounting records and/or financial statements act as proof which help in validating claims of the company. Additionally, it also forms a basis for a company to defend itself from claims against it.
Since an organization is an entity, various needs arise on a day-to day basis. Sound accounting & finance helps in addressing the current needs of the company appropriately and efficiently. Having a sound accounting & financial system also helps in making on-the-spot decisions such as make or buy decisions etc. as data relevant to the current situation is available on request in a reliable format. Finance & accounting also help in providing a cost analysis of projects along with potential revenue streams which is especially necessary for those take it or leave it decisions. Additionally, profitability analysis of a particular decision can be made immediately with the presence of a robust finance & accounting system.
A business needs to be valued for various purposes. As a start-up, business valuation helps determine how much the business will give to investors in exchange for seed money. Business valuation also provides updates about the company’s financial health. It is used to as the first step before fundraising and also used for the purpose of liquidation.
Sound accounting records & financial statements help in proper business valuation for investments and investors. They help is assessing the value of the business in terms of equity value, and also help in determining its viability for forming partnerships, joint ventures, acquiring interest in other companies or inviting investors.
On understanding what has been discussed above, it’s safe to say that accounting & finance are two very important functions of any business and also act as cornerstones to establishing a good business. Therefore, it is beneficial for a company to have a sound and robust accounting & finance system in place right from the beginning.
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