You can use the three core goals of financial management to determine which business ideas are most likely to help your business grow.
Hit 3 Goals with All Your Financial Management Strategies for the Win
Few entrepreneurs suffer from a lack of ideas, but knowing which ones should get the green light isn’t always apparent. Pursuing the wrong financial management strategies can result in wasted business resources, slowing or even stalling your business growth.
It’s important for every business owner to choose goals and values by which they can measure new ideas and initiatives, to be sure they will contribute to company growth. The three core goals of financial management can do just that. You may be surprised when you realize that these three core goals are about a lot more than just managing finances, demonstrating clearly how inter-dependent seemingly disparate business ideas really are.
Use these 3 Financial Management Strategies to Guide All Your Business Decisions
1. Will It Maximize Profits
It doesn’t take long for most new business owners to realize that more sales don’t always equate to more profits, and profit it what a business needs to reinvest in itself and grow more quickly. You should take the time to calculate profit relative to your business as a whole, and to each of the individual products and services you sell so that you understand:
- Gross profit margin (Formula: sales – cost of goods sold / sales)
- Operating profit margin (Formula: EBIT / sales)
- Net profit margin (Formula: net profits after taxes / sales)
Gross profit margin reveals the amount of profit your company earns after the cost of goods sold is deducted. The cost of goods sold might include the money paid to a manufacturer or distributor, cost of raw ingredients, cost of marketing and advertising, staff-related expenses and any other inputs. This shows how efficiently your company is using labor and supplies relative to the amount sold.
Operating profit margin compares earnings before interest and taxes (EBIT) to sales. High operating profits is an indication that the company is getting a good return on the cost of goods sold; conversely, low profits might indicate a need to reduce input costs or manage operations more efficiently.
Net profit margin shows what the company has after everyone has been paid, including the government. Net profits are ultimately the money your business has to invest toward growth, since all other revenues are eclipsed by the cost of goods sold and taxes.
Though many business owners think they have to increase prices in order to maximize profits, price isn’t the only factor contributing to profitability, as the formulas above illustrate. In fact, sometimes raising prices is the wrong way to maximize profits, if a price increase makes your business less competitive and you lose volume of sales which, at a lower price, actually result in the maximum profit your business can earn on a given item.
2. Will It Minimize Costs
It’s obvious from our discussion of cost of goods sold that minimizing business expenses can have a positive impact on your profit margins. The lower the cost of inputs and operating expenses needed to produce sales, the more money is left as gross profit (and ultimately net profit). However, just as raising prices isn’t always the best way to maximize profits, lowering costs isn’t always the best decision for your business.
For instance, what if you change suppliers based on your costs for the raw ingredients you need to produce one of the items your company sales, but your new supplier provides faulty or sub-standard quality materials? You may have temporarily decreased the cost of goods sold but may have increased expenses and reduced profits in the long term as your business has to handle returns, exchanges, customer complaints, bad reviews and customer defections.
As you can see, what seems to be the most obvious answer isn’t always the most accurate one. Let’s say you need to free up working capital in order to buy inventory and equipment to launch a new product or service. On the face of it, the ‘cheapest’ way to pay for the growth initiative seems to be to wait until you have the money saved up; however, this could be a costly decision. Competitors may outmaneuver you or new rivals could emerge and establish themselves in the market while you wait on the sidelines. In the long run, taking potential sales and profits into account, the less costly decision might actually be to take advantage of a merchant cash advance or business line of credit to grow more quickly.
3. Will It Maximize Market Share
Formula: Company sales / total sales in its industry (by geography, if applicable) over a certain period of time; in other words, of the sales possible during a given time period, what percentage did your business earn?
So far we have talked a lot about areas pertaining to finance and accounting; however, marketing concerns affect each of these three goals as well, and is obviously relevant to maximizing market share. Marketing (price, product, promotion, and distribution) decisions affect the cost of goods sold as well as company costs.
It’s worth noting that of all the reasons cited by entrepreneurs whose startups failed, poor marketing was actually the biggest reason startups failed. Yet for many business owners, marketing seems an afterthought; a topic they quickly try to master when projections don’t match up with results after opening their business or launching new product lines.
Maximizing market share is one of the core goals of financial management strategies for an obvious reason; more customers and less sales lost to competitors creates more opportunity to realize a profit. In addition, more sales often translate into lower cost of goods sold as inventory can be ordered in larger quantities at a lower price.