Business and financial goal-setting today isn’t like the goal-setting of yesteryear. Conventional goals like increasing sales and profitability are still important, but other financial objectives, including cash flow, flexibility and resiliency are coming to the fore.
John Miller, Chief Financial Officer at Addition, a London-based financial services firm, says the recession has had a “huge” but varied impact on how his clients approach financial goal-setting.
“On the one hand, we have seen it make some of our clients more optimistic and adopt a ‘let's go for it’ mindset.” While others take a more pessimistic or hesitant approach, with their targets either aim for substantial growth or excessive caution.
In an uncertain operating environment where businesses' goal-setting may swing between two extremes, how can SME owners set financial goals that make room for the unknown, while pressing ahead with ambition?
Selecting financial goals
The process of business and financial goal-setting begins with determining the long-term objective for the company.
“Concise goals that drive the key performance indicators are the best,” Miler says. “For example, if profit margins need to be improved, rather than saying ‘we need to improve margins,’ make it ‘reduced packaging costs to £1 a unit from £2 a unit’.”
Goal setting often starts and sometimes ends with sales targets.
“Financial goals are just a numerical representation of your company goals,” says Miller. “Framing a target as 5,000 sales units, for example, which just so happens to be £1,000,000, is more efficient.”
He recommends sales targets align with the frequency of sales: a barbershop might set daily sales goals and a consultancy quarterly goals for example.
“Think of the underlying assumptions,” adds Miller. “It’s best to build from the assumptions of ‘how do we generate revenue and what costs do we have?’, than to simply say, ‘let’s make £10,000 profit a month.’”
Matching your sales and financial goals helps businesses understand and action key business drivers. But Miller cautions against placing an overemphasis on revenue versus profit: “Anyone can sell £20 notes for £10. This would result in huge revenue but terrible profit. Therefore, the financial planning needs to be robust so as to set goals and specific performance indicators that will drive revenue and growth, whilst maintaining profit at a sustainable level.”
Revenue is a great goal to have to show growth, however, for the long-term, any topline goals should be matched with synced up bottom-line goals.
“It is understandable to lose profit margin as the business expands, but management must set a level that they are not happy to go below,” Miller advises.
In addition to shooting for a straightforward percentage increase in sales, many companies this year are looking for new sources of sales. A 2020 survey found that for over 50 per cent of small businesses, “the introduction of new products and services” was a key priority.
Cash flow goals
While sales and profits are essential for long-term business viability in any environment, 2020 also clarified how vital cash flow goals can be, especially when sudden and unexpected setbacks occur. Read our article to find out how to create a cash flow forecast to help navigate unexpected changes and make informed decisions during uncertain times.
Setting financial goals for cash flow and cash conversion—and monitoring the business’s progress in meeting those goals—guides future financial decisions.
“If you do not analyse cash flow when setting your financial goals, you may not realise that you need to find some extra funding for certain periods,” says Miller.
“Always work backwards with your cash flow strategy,” says Libby James, Co-founder of Merchant Advice Service. “SMEs should first establish how much they need to earn every month, and then work out the number of clients or sales required to reach that target.”
Cash conversion goals will typically vary depending on the stage and life cycle of a business. “For a high growth business we would expect everything to be reinvested in the business. So, when looking at cash conversion this would be close to zero,” says Miller. However, he suggests established SMEs aim for a cash conversion rate of around 70% of net profit. “A lower percentage could mean you are selling too much on credit and funding other businesses rather than your own.”
Miller advises to hold cash reserves of three to six months of fixed costs and use the “rule of three”: invest a third in a new product or further development, pay a third in dividends to shareholders, and retain a third.”
The limits of financial goal setting
Just as only setting sales goals isn't adequate for most businesses, setting only one financial goal for any given metric is equally unhelpful. A better way is to plan for uncertainty and have different goals for different scenarios.
Miller recommends business owners begin by setting a conservative plan and a stretch plan. “Ask yourself, ‘What do I need to cover my costs?’ This is a conservative plan. You should then set a stretch target, which is possible depending on variables, but means that you will be able to boost expenditure if you achieve them.
A conservative plan is set by thinking about all the income and costs that are deemed 80% likely to happen, says Miller. This plan may need to be tweaked to allow for the business to be sustainable by covering costs – so it might have certain elements which are 70% likely in terms of revenue and profit generation. Meanwhile a stretch plan feels just out of reach today, at about 125% of your conservative plan.
To measure progress towards your targets, Miller recommends reviewing the KPIs and the financials every month: “Compare the plan to the actuals and unpick the reason for any changes. Does this change your view of whether the plan is more or less realistic? If changes are dramatic, update the plan. If not, the plan should only be updated quarterly.”
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