The need for good reporting discipline
Being an owner-manager of a B2B software company can be demanding. While most of your time is rightly spent on a variety of sales effectiveness and product tasks. When it comes to finances most owner-managers simply just focus on whether there is enough cash to sustain or grow the business. While all this makes sense, it is prudent to invest a small portion of your time to set up good reporting discipline.
Reporting discipline is important for several reasons. First, it helps you to identify potential problems with your business early on so you can take corrective action. For example, if you see that your cash flow is declining, you can start to take steps to improve your collections or reduce your expenses. Second, reporting discipline helps you to track your progress and measure your success. By regularly reviewing your financial statements, you can see how your business is doing and identify areas where you can improve.
I’m not suggesting that you invest tens of thousands of pounds every month in setting up a sophisticated financial reporting process and hire a large team. This is not feasible and not required for small and medium B2B software businesses. However, you need to take care of the basic hygiene aspects. That is all there is to it.
An average owner-manager comes from a product background and is not comfortable with reading financial statements. For this type of owner-manager, our suggestion would be to just review the P&L every month. Your focus is to ensure that you are making profits. In a relatively stable software business, the profits should also be stable except for fluctuations triggered by non-recurring revenues. The other thing that you care about is: Are you generating enough cash? The focus here is cash conversion. A good cash conversion benchmark is 1x profit. A £100 profit should result in close to £100 of cash. If this isn’t the case, then either the debtors are not collected on time or creditors are not paid on time or both. This simplified focus around profit and cash conversion is foundational.
If you are a stable software business a 25% EBITDA margin is good. If it is lower say 10%, then it could well be the case that the company spends more on R&D or making investments in sales and marketing. In the former case of R&D, our view is that this should have been customer-funded. In an ideal world, all new R&D should be customer-funded but it doesn’t happen. In this ideal world despite the customer funding, the intellectual property still stays with the company. Customer funding does not always have to be 100% - they don’t have to pay 100% of billable rates; it can be discounted.
Four pain points to take care
It is good practice to track month-on-month management accounts covering the basics as stated earlier in this article. If you have a good accountant get the numbers and just factor in these four adjustments - Deferred income, Accrued income, Accrued liabilities and Prepayments. In our experience operating software businesses, the pain is driven by these four items. The traditional accounting software packages do not have an automated mechanism to track these adjustments. Thus necessitating the requirement to manually adjust for it. You could always try and automate these with the help of add-on software. For one of our operating companies, we are implementing an add-on software that could automate the tracking of these four items and reduce the pain points.
Here are some simple actions for each of these four items.
Simple guidelines for financial reporting discipline
Owner-managers are often busy with other tasks, such as managing their teams and developing new products. This can make it difficult for them to dedicate the time and attention that is needed to maintain good reporting discipline. There are several software solutions available that can help owner-managers track and analyse their financial performance. However, these software solutions can be expensive, which can be a barrier for some businesses.
There are many strategies that owner-managers can use to overcome these pain points. These include:
- Work with an accountant: An accountant can help you track your financial data and prepare your financial statements. This can free up your time so you can focus on other tasks.
- Use cloud-based software: Cloud-based software is a cost-effective and easy-to-use solution for tracking and analysing financial performance. There are several cloud-based software solutions available that are specifically designed for small businesses.
- Focus on key metrics: Don't try to track everything. Focus on the key metrics that are most important to your business. As stated earlier, the most basic KPIs to track would be profit, and cash flow (incl. cash conversion). See here for a detailed post on KPIs.
- Lastly, get comfortable with your financial statements: Take some time to learn how to read your financial statements. The more comfortable you are with them, the easier it will be for you to interpret the information and make informed decisions.
Summary
Reporting discipline is an important part of being an effective owner-manager. By tracking and analysing your company's financial performance regularly, you can identify potential problems early on, track your progress, and measure your success. There are some pain points that owner-managers can experience with reporting, but there are several strategies that can be used to overcome these pain points. By working with a bookkeeper, using cloud-based software, focusing on key metrics, and getting comfortable with your financial statements, you can establish good reporting discipline and make better decisions for your business.