Category: კატეგორიის გარეშე

We are often asked – why should I do budgeting? Budgeting is something that only big companies need, while small companies only have few transactions, and everything is clear even without a budget. But, is this so?

Why should a company have a budget?

Most of the people know that budget is a plan for future, however benefits of budgeting far exceed those of a simple forecast. We can tell from our own experience that budgeting has three crucial advantages:

Budgeting helps the management to clear their thoughts and express ideas in the form of a
plan

While carrying out his/her duties, a lot of ideas may come to the mind of a company’s director (manager) on what he/she could do in the future, how he/she can improve company product/service and increase profitability. For example, manager might think that it would be a great idea to form quality control department in order to improve product of service. Or he/she may think that it would be a good idea to stimulate sales through digital marketing. Budgeting is a tool for transforming these ideas in specific plans. Namely, during the budgeting process, manager is planning future revenues and expenses. Detailed budgeting of expenses pushes managers to transform one or more ideas that he/she has to a specific plan and input them in the budget. For example, manager could allocate funds for digital marketing in the budget and input the amount as a planned expense. Manager could also estimate salary expenses needed to form and run a quality control department and could input such expenses in the budget. If it turns out that forecasted revenues are insufficient to implement all the ideas that came to the manager’s mind, or in case of implementing all of them would lead to sub-optimal profits, then manager will be forced to prioritize the ideas and implement only those ones that he/she believes are more important. Therefore, it can be concluded that budgeting helps  managers to organize their ideas, transform them in specific plans and prioritize implementation timeline for ideas based on their relative importance.

Budgeting pushes managers to act

As noted above, company’s manager may come up with number of ideas regarding business development and related projects. However, often these ideas are never acted on. It is common knowledge that reflecting specific idea in a budget and translating the idea in specific numbers ultimately aids implementation of the idea, which aids company’s development and growth process. Besides, budgeting helps managers to forecast possible difficulties and plan respective measures to cope with those difficulties.

Budgeting helps to better understand and digest the company’s existing financial and non-financial position

During the budgeting process, in order to forecast the future, management is forced to dive deep into the company’s specific nuances and translate those nuances in specific numbers. During this process, management better acknowledges the existing resources, past experiences and most importantly, those key factors (so called “drivers”) that cause the company’s financial performance. As a result, management develops a better sense of existing circumstances and this aids more informed decision making in the future.

Conclusion

Budgeting is not a theoretical process with nominal value. Instead budgeting brings significant practical value to both large and small companies. Budgeting helps to organize thoughts, make better sense of company’s existing circumstances and pushes management to act.

What changed?

In 2018 important amendment was implemented in the field of finance, which significantly changed the state’s approach. Before 2018, apart from very small number of firms, companies did not have to publish their financial statements. Starting from 2018, state gradually introduced annual mandatory reporting.

Namely, companies were divided into four categories:

The first and second category entities became obliged to file 2017-year annual report no later than 1 October 2018.

Third category entities became obliged to file 2018-year annual report no later than 1 October 2019.

Fourth category entities became obliged to file 2020-year annual report no later than 1 October 2021.

What is the category assigned to your company?

Companies are assigned categories based on their sizes. The sizes depend on three criteria: 1) total assets; 2) revenues; and 3) average number of employees during the year. To be assigned a specific category, entity must satisfy at least two of the three criteria for that category. The below table will help you to ascertain your company’s category:

Does a mandatory audit apply to my company?

Based on the new regulations, the first and second category entities must conduct the mandatory audit. In other words, apart from the fact that the first and second category entities must publish their financial statements, they must also conduct an audit of those financials before publishing. As for third and fourth category entities, they do not have to conduct mandatory audit, which means that they only must prepare and publish financial statements, however they do not have to conduct mandatory audit before publishing.

What if my company fails to publish the mandatory annual report?

Failing to comply with the law will result in penalties. Failing to comply within one month from the receipt of warning notice from the state, penalty amount will double in size.

We are often asked – “what key financial measures should I constantly monitor to run a stable business and avoid unexpected losses?” In this article, we will be briefly discussing the answer to this question.

What is the required minimum information to control the financial aspects of a business?

Often company’s owners and managers, who have no financial background, make a mistake by assuming that it is sufficient to monitor cash balance at the end of each business day. They assume that if their company has cash available on its bank account, this means that all is good. Often, this is a huge mistake. In our practice, we often encounter companies that ran into financial problems or even went bankrupt.

In order to avoid financial problems, company’s manager needs to monitor at least the following three fundamental factors:

1. Monitor company’s profitability on a monthly basis
2. Constantly monitor company’s debtors and creditors
3. Constantly monitor and forecast company’s cash flows

Monitoring company’s profitability

Company’s manager needs to review and analyze monthly income statement. The statement shows manager the financial result and answers the fundamental question – did the company have a profit or loss in a given month? Let’s assume that the company had a loss of 1,000 GEL. This means that compared to previous month, either company’s liabilities increased by 1,000 GEL or company’s assets decreased by 1,000 GEL (or some combination of the two), which caused the company’s equity (assets minus liabilities) to decrease by 1,000 GEL. If a company has a loss over the period of consecutive months, this means that it accumulates liabilities, depletes assets or both. If this situation persists, equity will continue to constantly decrease, and the company will eventually go bankrupt.

Often company’s owners of managers make mistake by assuming that cash inflow is similar to profitability. Let us give you an example from our own experience: one of the companies operated on a loss over the extended period of consecutive months. However, due to specific nature of its business, the company collected advances from clients on not yet fulfilled orders. Such advances grew significantly along with the growth in the number of orders, leading to accumulation of cash on the company’s bank account.  Cash balance of the company grew by approximately 20,000 GEL on a monthly basis and the accumulated cash
balance was quite significant. The company’s owner assumed that the business was profitable. He was not monitoring the income statement. However, until the orders are not fulfilled, advances received from clients do not represent revenues and do not participate in the calculation of company’s profitability. Ultimately, when company got to fulfill the orders, it turned out that material expenses and salary costs needed to fulfill those orders far exceeded the accumulated cash balances. The company’s owners had to inject additional cash in the company to discharge the liabilities. In around one year, the company went bankrupt.

Monitoring debtors and creditors

Manager should constantly monitor company’s assets and liabilities in order to analyze the amounts receivable and payable. If the amounts receivable are much smaller than amounts payable and the difference gets larger over the extended period of time, ceteris paribus, this means that company’s cash balance grows not as a result of profitability, but as a result of liability accumulation. As described in the above example, accumulation of cash balance is not a guarantee of company’s profitability. In our example, if the company had monitored debtors and creditors, it would see that despite the fast cash accumulation, liability was accumulating even faster and discharging those liabilities would have led to significant financial difficulties.

Monitoring cash flows

There is another extreme – when manager only monitors income statement and does not monitor cash flows. It should be noted that in Georgia’s reality this case is less prevalent.  Nevertheless, ignoring the cash flows and respective forecasts may lead to company’s bankruptcy. For example, if a company has a contract that brings significant revenues, however the company is unable to collect cash from client/debtor, the revenues represent “paper” income and do not convert to cash. This situation may lead to company’s bankruptcy because it must pay salaries and other expenses, while, on the other hand, client has significant overdues or even does not pay at all. It is important to forecast cash flows, at a minimum, several months ahead. Namely, company’s managers shall plan expenses that a company will have to pay in the coming months and then shall plan cash inflows from clients. After this, manager shall match cash inflows and outflows and determine whether inflows are sufficient. This process can give company an opportunity to forecast any financial difficulties several months ahead and take actions to avoid them.

Conclusion

Based on our experience, if a company at a minimum monitors profitability, cash flows, debtors and creditors, it has strong grounds to avoid financial difficulties or at least foresee and prepare for them.