Published by Jack Foley, DoLearnFinance.com on 30-sep-2021

Introduction

It seems obvious that common sense combined with simple financial modelling would avoid many start up struggles by:

• Identifying potentially viable business models and
• Pivoting or killing bad business ideas at the bench-test stage to preserve the promotors’ energies for another venture with better prospects.

So it is almost an article of faith in HEIs and enterprise development organisations that entrepreneurs produce financial projections to assess the prospects of their business plans.

And alongside countless tutor-led finance courses there are modern technologies and supports such as the financial modules in the e-learning platform on www.difme.eu providing free access to the knowledge and tools needed to design commercially viable start-up business models and understand how to make financially-smart business decisions.

Yet despite all these supports and encouragements, many nascent entrepreneurs are happy to jump into business without seriously stress testing the financial viability of their business model. Even when they must produce projections for funding or for “marks” on a course they make only token efforts to understand what they mean and how they are inextricably linked to the targets promised in their business plan.

This situation has not arisen by accident: if you are a teacher, trainer, banker or adviser working with start-ups and microentrepreneurs you may be part of the problem!

In this brief article we will:

• Identify the aspects of financial skills that are relevant to microentrepreneurs
• Look at how well microentrepreneurs are served by trainers and educators
• Examine how key influencers - state agencies and banks affect attitudes to financial skills
• Imagine how the MSE sector would appear were all players took their roles more seriously.

The Financial Perspective – The financials skills relevant to microentrepreneurs

Microentrepreneurs don’t need to know double entry bookkeeping but they must have an unambiguous grasp of:

1. What projected Profit and Loss Account, Balance Sheet and Cash flow projections say about their business model
2. How tactics/decisions about prices, scaling, costs, investment in fixed assets, and the scale and sources of funding shape the profitability and sustainability of their business.
3. Adaptable business strategies to create mixes of the above tactics to define successful business models.

Finance is the language of business; its terms communicate complex business situations effectively and financial statements are nothing less than the scorecards of business.

The lockstep relationship between business and finance

Business and finance are not separate activities but work in lockstep. The idea of making significant decisions (much less constructing a business model) without examining the resultant financial statements makes no sense. Simply working back from the financial statements to their real-world determinants as in Table 1 below shows the Gordian Knot that links business and finance.

Table 1: The Financial Perspective Algorithm

Financial Statements & Goals	Triggers	Core Questions
Sales Goal to increase	Selling Prices Sales Volume	Can I gain volume and/or higher selling prices through: ·          Focusing on “winners” and marginalising “losers” in my product/service range ·          Redesigning products/services and developing new ones ·          Developing new markets ·          Expanding current markets ·          Smarter promotion and advertising ·          Improved sales control systems to reduce unnecessary discounting, unrecorded sales etc.
Cost of Sales (Materials) Goal to reduce	Purchase Prices Utilisation	Can I reduce my cost of sales/materials by: ·          Eliminating or reducing materials by redesigning Products/Services ·          Substituting cheaper materials which still maintain required quality standards ·          Finding better suppliers ·          Negotiating better prices and discounts ·          Purchases Control Systems to avoid overpayments.
Labour Goal to reduce	Rate Efficiency	Can I reduce my labour costs by: ·          Negotiating Wage/Salary cuts ·          Better planning to avoid idle time ·          Improving work Practices and Methods ·          Designing or acquiring Tools/Technology to increase productivity
Overheads Goal to reduce	Purchase Prices Utilisation	Can I reduce my overheads by: ·          Using other suppliers ·          Making changes in the workplace and work practices to reduce insurance ratings ·          Encouraging more “cost aware” work practices ·          Targeting “Volatile” items e.g. travel expenses and phone bills. ·          Maintaining internal controls to ensure expenses don’t creep up.
Capital Secure the right amount and don’t over-borrow	Equity Long Term Loans	Have I: ·          Stress tested my plans and projections to ensure that I have enough capital to meet predictable outcomes ·          The right growth/safety balance between owners’ v. borrowed funds
Current Liabilities Be smart and fair	Creditors Short term loans/overdrafts	Have I: ·          Agreed fair and sustainable credit terms with suppliers ·          Identified short term peaks in my cash requirements and arranged facilities
Fixed Assets   Judged by the sales and/or profit they generate	Hire Buy	Do I: ·          Have an effective process to measure the cost/benefits of asset acquisition ·          Hire rather than buy when I cannot be certain of the long-term benefit delivered by the asset ·          Avoid vanity buys that are likely to turn into “White Elephants”
Current Assets   Minimise within prudent SLAs	Inventory (Stock) Debtors Cash and equivalents	Do I have systems and procedures to: ·          Ensure that stock levels are as low as possible but responsive to prudent customer service levels and impending changes in prices and delivery conditions ·          Collect cash from debtors on time ·          Plan and monitor cash flow to maintain adequate cash balances and utilise surpluses

Converting the financial perspective into a simulator to stress test start-up business models

Modern computer technology makes it easy to create dynamic software models to game the components illustrated in Figure 1 and fine-tune business models to give business ideas the best possible chance of surviving and thriving.

Good models will clearly separate lockstep relationships from assumptions.

Lockstep relationships

These are hard wired relationships coded into the programme and link the metrics in the business model (prices, costs, scale, funding, and capital investment) to the values in the financial statements.

For example, an increase in selling prices (all else remaining the same) will cause the sales figure in the Profit & Loss account to increase in direct proportion and all other connected values (debtors, cash, profit and so on) will change in lockstep.

Business Assumptions

Business assumptions relate to uncertainties such as the impact a change in one driver will have on another e.g. how much the numbers sold (sales volume) would change in response to a higher price. This is the stuff of “What-if?” exploration and down to the judgement of entrepreneurs and their advisers.

Figure A is a snapshot from an application which connects a high-level business model to its financial statements. The metrics in the business model (column one) are user-determined and automatically generate those in the three financial columns. To appreciate the financial perspective consider two situations:

1. One where the three columns to the right of the business model column were completely blanked out i.e. the situation where microentrepreneurs ignore the financial perspective
Against...
2. One where microentrepreneurs can see and use the information in the three financial columns to create a rapid feedback loop to fine tune their business model and rapidly embed financially smart decision-making as an ingrained skill.

Figure A - Linking business and financial models

Sadly, situation 1 is the more common and exemplifies the fundamental problem at the core of this article.

Finance for microentrepreneurs is not about the rules of preparing financial statements, it is a perspective that helps them to make smart business decisions and fine-tune business models. It is about developing concepts and skills to systematically link business activity to the three generic business goals of profit, cashflow and asset-utilisation.

It is also a language to communicate business information concisely and clearly. In the remaining sections of this article, we will explore why microentrepreneurs need that perspective (as opposed to leaving financial matters to accountants) and how we can best help them embrace it.

The Financial Perspective and business failures

The levels of early failure for new ventures are high. Obviously, not all failures are caused by a lack of financial skills but we can classify the causes of failures as:

1. Those arising from events that could not easily have been anticipated and
2. Those that could have been avoided by prudent financial analysis.

Business Failures Type 1 – Force Majeure

“Events, dear boy, events!” is said to have been former British Prime Minister, Harold Macmillan’s response when asked what could go wrong when all omens predicted success. In business, ‘events’ can be things such as:

• No adequate market or “gap in the market” for the product/service in the first place
• Being too early or too late to market
• Unexpected and radical changes in market tastes and preferences
• Disruptive innovation by a competitor
• Legislation and regulations
• Logistics barriers e.g. distribution channels closing or becoming too expensive

These are part of the cut-and-thrust of business, some are difficult to anticipate and defend against. We can often describe them as bad luck and largely exonerate the entrepreneur.

Business Failures Type 2 – Flawed Business Models

These are situations where the business model was fatally flawed from the outset. Poor policies such as:

1. Prices too low to generate adequate profit margins
2. Creating overhead fixed-cost structures too high to be absorbed by any realistic sales projections
3. Buying equipment (capital investment) which is never likely to be justified in terms of the profit it would generate
4. Failing to think through working capital policies/practice and tying up capital in excessive inventory and debtors
5. Underestimating the funding needed or relying too heavily on borrowings

These failures would have been avoided by the financial perspective because their impact on profit and cash flow should have been obvious in any effective financial model.

The policies would still have rested on assumptions about customer behaviour, competition, technology and future socio/economic environments, but that is in the Type 1 area.

The essence of business planning and decision making is not about predicting the future (no one can) but about shaping it through formulating sensible strategies and then doing everything possible to realise them.

While the financial perspective will not prevent all business failures, it will prevent some and it will certainly help microentrepreneurs formulate and communicate the best possible business model for their enterprise.

What about the influencers who shape the attitudes towards financial skills in the MSE sector?

How well do trainers us digital technology?

We have the technology to create online modelling applications to let learners focus totally on specific learning objectives and avoid unproductive time on calculations and technicalities which do not contribute to the learning goals. Cloud-based resources and websites such as www.dolearnfinance.com (which we borrowed from in Figure 1) can host highly effective learning aids such as videos, exercises, tests, workbooks and modelling applications.

Digital Technology can:

• Take beginners from zero knowledge to producing professional standard financial models and projections in days rather than months
• Offer learning situations that are almost identical to the real business world but without the high cost of learning-through-experience
• Free learners to learn what they want, when and where they want

Cloud-based learning suits financial training in particular because the very modelling applications used to learn are suitable in real business situations so that users not only learn-by-doing, but can do-while-learning.

How many of us trainers/educators make the effort to maximise the benefits of these new tools and redesign our courses as opposed to merely uploading old notes and spreadsheets?

How well do course leaders manage the financial elements of their entrepreneurship programmes?

Do course leaders of enterprise development courses vet the finance element to make sure it is not just a reworking of accounting lectures with minimal tweaks and no genuine empathy for a non-financial audience?

Do course leaders perpetuate indifference to financial skills in entrepreneurs by themselves not taking the time to learn relevant financial skills. There is little excuse as what they need to know is interesting and simple to acquire.

The minimum microentrepreneurs could expect from the education and training sectors is that we:

• Update course design and materials to maximise the power of modern ICT or find websites which are up-to-date and use them
• Use flexible learner-centred delivery methods with blended learning and flipped classroom techniques
• Keep ourselves up to date on modern technologies and applications which deliver high quality education and training

Do State Agencies and Banks Create the Right ‘Atmosphere’ – Good Practice Needs Encouragement

In one of life’s strange coincidences I googled ‘The Bolton Report’ when preparing this article and found the following quote from the address by The Earl of Courtown to the House of Lords in 1973 about The Bolton Enquiry into Small Firms in the United Kingdom:

In what I say today, I propose to concentrate on the problems of management in small firms, because it is on management - and good management in particular - that these firms either will or will not flourish. It has been brought out very clearly by previous speakers that it is difficult to make small firms accept a service, even if that service will be useful. There must be an atmosphere among small firms inducing them to make use of that service. Hansard, 1803–2005, HL Deb 21 February 1973 Vol 339 cc154-73.

The bold emphasis on the last sentence is mine, but how do we create that “atmosphere”?

The most obvious influencers are state-agencies and banks and I have direct experience of working with both in financial education for micro entrepreneurs and owner-managers of MSEs.

State Interventions

The state agency rolled out heavily subsidised training programmes which despite the quality of the learning content and trainers, at least in terms of the technologies available at the time, enjoyed limited success and certainly failed to create that “atmosphere”. That was back in the 20th century but as far as I can see the results in terms of financial skills programmes are no better today with low take-up and no discernible change in “atmosphere”.

Many microentrepreneurs remain too busy doing business to think about making money.

Bank Initiatives

As far back as 1990, I worked on a joint venture with a major European bank on an intervention to improve the standards of financial awareness in the MSE sector. The idea was to provide a dedicated software application enabling microentrepreneurs to produce clearly thought through, technically correct, financial forecasts. The “atmosphere” would be created by restricting loan approval to businesses with viable projections and evidence to support the underlying assumptions.

Unfortunately, the initiative foundered on an entirely unrelated event (a classic “Category One” failure). The software survived and flourishes to this day but this early example of a serious effort to establish good practice, add value to the process of loan approval and reduce loan defaults was never fully revived within the innovating bank nor has it been emulated by other banks.

Most banks offer online spreadsheets of varying quality, downloadable information sheets and workshops on various aspects of business planning, but as far as I am aware none insist on evidence of financial awareness and are happy to deal with intermediaries without verifying the microentrepreneurs input or even understanding of the financial projections submitted on their behalf. There may be good reasons for this and I do not wish to imply tokenism on behalf of the banking sector, but my interactions with microentrepreneurs and accounting practices suggest that the lessons of the 2008 crash are long forgotten.

A Modest Proposal

One simple improvement to this practice lies in rigorous financial perspective training for front-line advisers in enterprise support agencies and the banks. Many of the advisers I have encountered share a solid understanding of business and excellent relationship skills. Their weakness is that they lack the very financial skills which microentrepreneurs require and this directly perpetuates the financial skills gap in nascent entrepreneurs.

Both banks and enterprise development agencies should ensure that client facing advisers are proficient in producing and interpreting projected Profit & Loss Accounts, Balance Sheets and Cash Flows for MSEs and convey the importance of this competence rather than model the attitude of “let’s leave it to the accountants” which is at the heart of the problem.

Conclusions

There is a financial-skills gap in the MSE sector which is so prevalent and long established that it can seem intractable. The major causes of this are:

• The perception among microentrepreneurs that the subject is dull, obscure and best left to accountants
• The failure by key decision makers in education, training, banking and enterprise support to provide good authority and practical actions to correct the problem.

The reality is that the elements of accounting and finance needed to make smart business decisions and understand the interplay between business and finance are engaging and easy to learn. The problem, far from being intractable, is relatively easy to fix because modern technology has removed the drudgery of calculations and the need to learn obscure little technicalities. Sites like www.difme.eu and www.dolearnfinance.com automate all the traditionally cumbersome barriers to learning and make the beneficial elements clear and accessible.

In the opening section I suggested that teachers, trainers, bankers and advisers were part of the problem. I will now identify the final culprits - microentrepreneurs themselves. They need to step back a little from being busy with business and adopt a financial perspective.

It is hardly a pipedream to picture an MSE sector where:

1. Microentrepreneurs embrace the financial perspective as an important skill
2. The language of finance is spoken empathetically by experts
3. Educators and trainers use technology competently and enthusiastically
4. Banks and enterprise support agencies ensure that their front-line influencers have the skills and attitudes to demonstrate the importance of the financial perspective and resolutely act to maintain it

What would the socio/economic benefits be if we could prevent ten, five, even one percent of business failures?

Jack Foley
Jack is an economist and trainer focused on helping entrepreneurs use simple financial techniques to avoid going into business with flawed business models. He has designed and delivered national training initiatives, developed and brought to market financial software applications and provided innovative training and advisory services to countless entrepreneurs and their advisers/educators over the past three decades. Recently he has worked on the development of innovative active-learning websites such as www.dolearnfinance.com, www.difme.eu and www.dothefinancials.com