u Essential Elements & Tools of Financial Management

FINANCIAL for MSMEs

MANAGEMENT FOR u

u
Business Budgets and Forecasting Models
Drafting your Financial Projection
MSMEs u Preparing and Interpreting Financial Statements
u Warning Signs of Financial Difficulty
 INTRODUCTION
Financial Management is the umbrella term for thorough
bookkeeping, making accurate projections, and creating financial
statements and accessing business financing. It is the practice of
planning, controlling, directing a business’ finances in a way that
allows it to be successful and maintain its good standing.

The fundamental elements of Financial Management include;

Capital Budgeting, Working Capital Management. Each
element has a direct and important effect on the business’
balance sheet and on the firm's profitability. Managing these
elements efficiently will enable you make decisions to run
your company successfully.
ESSENTIAL ELEMENTS & TOOLS
OF FINANCIAL MANAGEMENT
FOR MSMES

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 Financial Planning and Projection: This involves setting financial
goals, plans and measures towards achieving them. This includes
budgeting, financial modelling and forecasting methods.

ELEMENTS OF Working Capital Management: Working capital is the difference

between current assets and current liabilities. Working Capital
FINANCIAL Management involves tracking liquidity (cash flow) of the
business. Optimum working capital – not minimum or maximum
MANAGEMENT but optimum working capital is the ultimate position a business
should maintain.

If a business has too much working capital, then you incur costs
of funding unemployed assets that resemble interest which can
and should be avoided. Very little working capital can also have a
disastrous effect on your business. The major components of
working capital are inventories, receivables, cash, and payables.
 Assessing & Managing Risk: Risk simply means a
possible adverse event or outcome. An occurrence
contrary to what was expected. It can be
operational, or relate to liquidity, market, or credit.

ELEMENTS OF Capital Structure: This relates to the composition of

FINANCIAL an organization’s capital. The debt and owners'
capital that make up a business finance.

MANAGEMENT

Investments and investment decision-making

Importance of Financial Management to Small Business
Financial management is important because it helps the business:

See and Make decisions on Determine whether it Provide banks and Conduct sound
planning inventory and has sufficient cash flow investors with the financial analysis for
understand its
setting prices to sustain operations financial reporting they better business
profit and make decisions on need to loan money or forecasting and
buying assets invest in the business projections

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TOOLS OF FINANCIAL MANAGEMENT FOR
MSMES

Adopting Suitable Software: Using software that enables easy accounting and
book-keeping can be beneficial for MSMEs.

Automating Daily Processes: Online catalog to detail products and services, using
technology platforms to register pending orders, and producing automated bills
and payment slips instead of manual entries, etc. can be adopted. This will not
only save time but improve the efficiency of the business.
Financial Management Challenges faced by SMEs
Managing a budget;
It helps you prepare for unforeseen
circumstances and make strategic
decisions, like when to expand or hire
new employees.
Secure Financing;
This can hamper growth by not
taking advantage of business
opportunities when they arise, like
making capital expenditures for
new equipment that could lead to
increased revenue.
Meeting Operating Expenses with
Cash Reserves;
consistently paying employees, payroll
taxes, employee health benefits and the
owners’ salaries from available cash is a
strong indicator of financial health.
Controlling debt;
whether it’s a small business loan or any
type, sometimes taking on debt makes
financial sense. But taking on too much
debt, or not meeting payment terms can
affect your earnings, increase the amount
you pay in interest and drag your business
down.
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KPIs and Metrics for Financial Management
1. Profitability;
The income statement (or profit and loss (P&L) statement) helps a business see its overall profit
or loss during a given time period.

A. Gross Profit Margin: Total Sales – (Cost of Goods Sold)/ total sales *100

**Higher gross profit margins indicate your company is efficiently using its assets to generate
profits.

B. Operating Profit Margin: Operating Income/ Revenue *100

** Also known as EBIT. Increasing operating margins can indicate better management and cost
controls within your company.

C. Net Profit Margin: Net profit/ Sales*100

**Higher net profit margins indicate that your company is efficiently converting sales into
profit

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 KPIs and Metrics for Financial Management
2. Efficiency;
Some metrics gauge how well your company is using its capital and assets to generate revenue. For these
metrics, you’ll need information from your income statement and balance sheet, which is a snapshot at a given
time of how much your company owes and how much it owns..

A. ROA (Return on Assets):

Net Income / Average Value of Assets x 100

**How efficiently does your business convert money invested in assets into profits?

B. Working Capital Ratio;

Working capital ratio = current assets / current liabilities

** This ratio is a measure of liquidity and indicates your ability to pay short-term liabilities. A ratio of around 2
indicates good short-term liquidity.

C. Working Capital Turnover

Net Annual Sales / Average amount of working capital for the same year

**It’s an indicator of how well you’re using capital to generate sales.

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KPIs and Metrics for Financial Management
3. Solvency;
To measure solvency, or your company’s ability to pay its long-term debts, use the cash
flow statement, which measures how much cash enters and leaves your company.
Calculating operating cash flow will indicate how well the company can cover its current
liabilities.

A. Operating cash flow ratio =

net income + non-cash expenses + changes in working capital / current liabilities

**If operating cash flow ratio is 2, for instance, it means your company earns N2 for every
naira of liabilities. Another way to look at it is your company can cover its liabilities twice
over.

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Small Business Financial Management Tips
1. Create a budget; Track
your monthly expenses and
compare them against historical
expenses. When you see potential
problems, such as overspending or
a lack of capital, put plans in place
to address them.
3. Create a Cashflow
Projections; Make sure cash
inflows from accounts receivable
will cover cash outflows. This is
particularly important for seasonal
businesses.
5. Build Financial
Knowledge and Strength.
Start developing a profit plan
when seeking a loan. It should
include a statement of purpose, a
list of the business owners, a
description of the business and
how it makes money, financial
statements and other
documentations.
2. Put sound bookkeeping
in place; Get business
accounting software, such as;
Zoho Invoice, Quickbook,
Loyverse.
4. Get a Business Account;
It helps you separate your
personal spending from your
business.
6. Get Help as Business
Grows; If possible as your
business grows, employ an
accountant to handle things like
accounts payable, accounts
receivable, reporting and financial
statements, putting financial
controls in place.
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 BUSINESS BUDGETS &
FORECASTING MODELS

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Why you need a small business budget?

Financial health check; It lets you know if you have enough funds for generating
revenue, operating expenses, and expansion.
Achieve long-term goals; Know whether you need to cut expenses or increase revenue
to achieve your strategic, operational, and financial goals.
Grow your business; Investors or lenders will first look at your income and expenses
before investing in you.
Maintain financial security. It helps keep the doors open in case of a recession, off
month, a downturn and slow payments.
Capitalize on opportunities.With a budget in place, you won’t miss out on any
valuable opportunities for profitability.

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 Why you need a small business budget?
Tally Your Income Sources; When building a small business budget, you need to figure out how
much money your business is bringing in each month and where that money is coming from.
Sources of Income; Sales, Consulting, Freelancing, etc.

Determine Fixed Cost: Your fixed costs are any expenses that stay the same from month to month,
year to year.
Examples; rent, certain utilities (like internet or phone plans), website hosting, and payroll costs.
Review your expenses via your bank statements to determine which costs have stayed the same from month
to month. These are the expenses you’re going to categorize as fixed costs.

Tip: If you’re just starting your business and don’t have financial data to review, make sure to use projected
costs.

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Why you need a small business budget?
Variable costs; are cost that vary each month based on your business performance and activity.
These can include things like shipping and delivery costs, sales commissions, advertising and publicity.

Variable expenses change from month to month. When your profits are higher than expected, you can
spend more on the variables that will help your business scale faster. But when your profits are lower
than expected, consider cutting these variable costs until you can get your profits up.

Discretionary Expenses: Discretionary expenses are also considered variable expenses

because while they are nice to have, they’re not essential for your business. These include things like
education, consulting, etc., which might help increase profitability.

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Why you need a small business budget?
Create a Profit and Loss Statement:
After gathering all the data above, it’s time to assemble all the pieces of the jigsaw puzzle to
make sense of it all.That means creating a profit and loss (P&L) or income statement, like this one
shown below.

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 Financial Modeling for Small Business

• Do you want to build a (financially) sustainable business?

You need one to build an economically viable business.
• Are you looking for funding?
Financiers will typically ask you for a financial plan when you engage with them to raise funding,
whether them being angel investor,VC, bank or subsidy provider.
• Do you want to avoid going bankrupt?
How are you going to update your shareholders on how you are spending their money and
whether you are performing as promised without any financial plan to benchmark against?

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 Different Approaches to Financial Modelling for Startups
• Top-down Forecasting
The top-down method helps you to define a forecast based on the market share you would like to capture within a reasonable timeframe. A useful aid to perform top-down
forecasting is the TAM SAM SOM model which captures the market size in 3 levels: the total worldwide market for a product or service (TAM: total available market), the niche
market adjusted for your geographical reach (SAM: serviceable available market), and the part of SAM you can realistically capture (SOM: serviceable obtainable market). SOM is
therefore equal to your sales target as it represents the value of the market share you aim to capture.
20 Billion
Naira
10 Billion
Naira

2 Billion
Naira

Based on the sales targets you define using the TAM SAM SOM model the next step is to estimate all costs that are needed to build or deliver
your product or service and all expenses that are needed to perform all sales and marketing, research and development, and general and
administrative tasks for your company to stay alive.

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 Different Approaches to Financial Modelling for Startups

• Bottom-up Forecasting;
The pitfall of the top-down approach is that it might seduce you to forecast too optimistically. However, the bottom-up approach is less
dependent on external factors (the market), but leverages internal company specific data such as sales data or your company’s internal
capacity.
With the bottom-up approach, you estimate revenues, costs, expenses and investments in the same way as described above: based on the
resources at hand and the company data that is available.

The pitfall of the bottom-up method though is that it might fail to show the optimism needed to convince others of the potential of your
company.
When you build your startup’s forecast, it could be advisable to combine both the bottom-up and top-down methods, especially when you
plan to achieve a strong growth curve by means of external funding. Use the bottom-up method for your short-term forecast (1-2 years
ahead) and the top-down method for the longer term (3-5 years ahead)

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 Assumptions

No matter what approach you use to build your startup’s financial model, it is crucial you are able to substantiate your numbers with
assumptions.
Assumptions can be anything that validate your numbers:
v market research,
v web search volume,
v contracts with suppliers,
v pricing validation,
v historic sales,
v conversion rates,
v bills of materials,
v website traffic, etc.
It could be useful to create a “data room” (e.g. a Drive folder) in which you collect these kinds of evidence. By doing so, you are slowly building
a library that underpins all the numbers you have put in your model and you are well prepared in case an investor might request a due diligence
process.

Every sector, company, business owner and investor is different, but a good financial model usually contains at least the three outputs:
• the financial statements;
• an operational cash flow forecast; and
• KPI overview.
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 Walkthrough Session on Business
Budgeting Template

Activity: Mention 6 financial management tips you know

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DRAFTING YOUR FINANCIAL
PROJECTION

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 Drafting your Financial Projection

Financial Projections incorporate current trends and expectations to

arrive at a financial picture in the future. Whether you manage an
existing business or planning to start a new business, you need to
prepare Financial Projections for your business plan.

Similar to creating a budget, Financial Projections help you

forecast future revenue and expenses for your business.
• Short-term Financial Projections: Such projection covers a year and
are typically broken down by month.
• Long-term Financial Projections: Such projection typically cover the
next 3-5 years and are usually used when creating a strategic plan or
for attracting investors.

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 STEP 1 Gather accurate financial statements & data.

Create an expense projection based on fixed expenses,

STEP 2 possible one-time expenses, and include an additional
15%.

STEPS FOR STEP 3

Create a sales projection based on past performance or
market research.

DRAFTING YOUR 1- Create a balance sheet projection to predict your

STEP 4 financial position for next year – listing your assets,
YEAR FINANCIAL liabilities, and equity balances.

PROJECTION STEP 5
Create an income statement projection to provide a view
of your possible net income.

Create a cash flow projection using your cash flow

STEP 6 statement (if your business has been operational for at
least 6 months) or using reliable data (if you are in the
start-up phase)
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PREPARING & INTERPRETING
FINANCIAL STATEMENTS

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Financial Statement

Any decent financial model includes a forecast of the three financial statements:
• the profit and loss statement (P&L),
• the balance sheet (BS) and
• the cash flow statement (CF).
The financial statements are the generally accepted way of communicating financial
information across companies, banks, investors, government, etc.

The profit and Loss;

Or Income statement is basically an overview of all the income and costs your company
has generated over a specific period of time and shows you whether you are profitable or
not.
Its metrics includes; Gross margin, EBITDA and Net margin. EBITDA is very important for
investors as it provides insights in the operational performance of a company and allows
them to compare efficiency when comparing different companies.

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Financial Statement- Balance Sheet

Balance Sheet: The balance sheet is an overview of everything a company owns (its
assets) and owes (its liabilities) at a specific point in time.
Liabilities show the obligations of a company and how it has financed itself using debt,
whereas Assets show how these funds are used within the company.

The difference between the value of assets and liabilities consists of Equity, which is the
paid-in capital by investors that finance the assets not covered by debt (assets = liabilities
+ equity).

Because of this the balance sheet is always ‘in balance’. Shareholders' equity represents
the net value of a company. In other words: the amount that would be returned to
shareholders if all the company's assets were liquidated and all its debts repaid.

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Financial Statement- Cashflow Statement

The cash flow statement shows all cash going in and out of a company over a specific
time period. The cash flow statement consists of three different parts:
• the operational cash flow,
• the investment cash flow and
• the financial cash flow.
The separation between these three categories provides you with insights on where
money is going in and out of the company.

Operational cash flow shows the cash inflows and outflows caused by core business
operations.
Investment cash flow shows changes in investments in assets and equipment.
Financial cash flow relates to cash changes arising from financing activities.

In summary, the cash flow statement allows management to make informed decisions on
business operations and allows it to prevent and monitor company debt.

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Operational Cashflow

For fundraising purposes a forecast of the financial statements is typically shown on a

yearly basis. For the actual day to day financial management of your company it is useful to
include an operational cash flow for the coming 12 months ahead in your financial model.

It provides you with an opportunity to track your actual performance versus your
expected budget on a monthly basis, which helps you cut costs (if needed) and anticipate
potential cash dips months ahead.

To build an operational cash flow forecast;

• list all the categories of cash inflows and outflows (for instance in an Excel),
• add a starting balance (the cash you own at this very moment)
• and see what remains at the end of each month.

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KPI Overview

KPIs (Key Performance Indicator) do not only matter for an investor, but also for you as a
business owner. Based on these metrics you track the performance of your company,
experiment with different acquisition channels, business models and cost structures, and
you use them to make you and your co-founders laser-focused on the targets you defined.

There are KPIs that show sales and profitability performance (such as revenue growth
rate, gross margin, EBITDA margin or profits), KPIs related to cash flow and raising
investment (such as the burn rate, runway and funding need breakdown) and company or
industry specific KPIs.

We will talk more on the KPI under how to interpret financial statement.

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 The Inputs to a Startup’s Financial Model

Revenues;
Forecasting revenues is typically performed using a combination of the top down (TAM SAM SOM model) and
bottom-up methods.
q List all the products or services that you are selling.
q Determine in which units you want to present your sales: for a soda producer, this could for instance be bottles
sold, but also liters sold.
q Forecast per sales unit the number of units sold. This is based on the top down and bottom-up analysis you
have performed above.
q Add selling prices. Check out our article on new product pricing strategies if you want to learn more on how
to determine pricing.
For service-based business, you can look for a financial modeling template for specific companies or business
models on the web or forecast based on existing customers, new customers and the churn rate.

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The Inputs to a Startup’s Financial Model

Cost of Goods Sold

Cost of goods sold (COGS) are those costs that undoubtedly need to be made in order for a company to
deliver a service or produce a good. Without these costs, the product or service would simply not exist.
COGS differ based on the type of offering you sell. For a company that sells tangible products they would
include for instance;
the costs of the materials used in creating the good.
For a company that sells consultancy hours they would include the personnel costs of the employees
delivering the service.

Example: if you sell plastic bottles, you could calculate how much plastic you need per bottle and what would be
the price of a kilogram of plastic. Moreover, you need to know how much paper label you need per bottle and
what is the price of that. Also, you need to know the costs of the cap.

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Operating Expenses

Operating expenses are those expenses that a business incurs as a result of performing its
normal business operations. Unlike the cost of goods sold, they are not necessarily needed
to produce the goods that are sold or to deliver the services promised. They include costs
related to the supporting and operational side of business, such as sales and marketing,
research and development and general and administrative tasks.

If you are not sure about which expenses you might incur in the long term, you could always save
a certain percentage of your revenues for the different expense categories. E.g. you could include
10% of your yearly revenues on a budget for sales and marketing activities.

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 Personnel

Personnel is probably one of the easier forecasts to build. With your personnel forecast you project the number of
employees hired including their respective salaries, additional benefits and payroll taxes. To make personnel
forecasting simple, you could split up your personnel into different categories, for instance:
v Direct labor: here you include the employees that will be solely engaged with the production of the goods sold or
services delivered.
v Sales and marketing: for instance, sales managers, marketing managers, copywriters, social media experts, etc.These
employees are part of your operating expenses.
v General and administration: here you include back office and C-level personnel, such as the CEO, CFO, CMO,
secretaries, bookkeepers, etc.

Investment in Assets

Capital expenditures are funds used by a company to acquire or upgrade physical assets such as physical property,
intellectual property, buildings or equipment. This type of expense is made by companies to maintain or increase
the scope of their operations. They can include everything from repairing a roof to building a brand new factory.

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Financing

The final potential input sheet of a startup’s financial model could be a financing module. In this
sheet you would add financing streams such as equity, loans or subsidies. The main goal of this
would be to check the impact on your funding need when you add different types of funding in
different years of the model.

When a model includes the possibility to input loans, it needs to account for the loan repayment and
interest payments, as these have an impact on cash flows.

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 Financial Statements provide a look into the
financial life of a company and reveal key
indicators of the financial health or
weakness of the company within a reporting
UNDERSTANDING THE period – whether monthly, quarterly or
annually.
BALANCE SHEET,
INCOME STATEMENT,
AND CASH FLOW The 3 key parts of a Financial Statement are:
STATEMENT Balance Sheets, Income Statements (also
called Profit & Loss Statements or P&L
Statements), and Cash Flow Statements.
SUMMARY NOTE FOR THE THE BALANCE SHEET
The Balance Sheet shows the state of the company at the end of the reporting period, not the
activities along the way.
COMPONENTS OF A BALANCE SHEET

Assets (valuable properties, cash, investments, patents, or

trademarks owned by a company). Assets can be current
(liquidated within a year) or non-current (will take longer
than a year to sell).

Liabilities are debts the company owes for supplies,

business loans, rent on a property, payroll, and other
obligations. Liabilities can also be current or long-term.

Shareholders' Equity (also called Capital or Net Worth) is

the cash value of the company, if all assets were to be
sold and all liabilities paid off.
WARNING SIGNS OF FINANCIAL
DIFFICULTY

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WARNING SIGNS OF FINANCIAL DIFFICULTY
Negative Cash Flow: The
Note: Symptoms are not first sign things are going
causes, rather they are Low or Declining
Profitability: Poor wrong is a constant lack of
indicators to what could cash. You are profitable,
be wrong or what needs profitability.
but do not have positive
to be amended.
cash flow from operations

Defaulting on bills or
extended creditor days: Increasing Overhead Costs No access to finance
Inability to pay your debts.

Inadequate financial Extended debtor: Slow

records. Defaulting on bills paying customers
THANK YOU