The Crucial Elements of the Financial Decision-Making Process

The reality is that every business venture can, at some point, be exposed to financial instability.  In the case of MSMEs, lack of sufficient and timely access to finance is typically a leading reason for business failures. The consequences of becoming illiquid can have a detrimental effect on business operations, forcing them to declare insolvency. MSMEs are more susceptible to broader economic conditions, thus, smaller enterprises’ survival rates are low compared to larger entities as MSMEs generally do not have the long-term capacity to withstand economic downturns. The increasing numbers of MSMEs exits and failures exacerbated by the COVID-19 worldwide pandemic emphasise the importance of understanding the reasons that could lead to this extreme outcome.

Recognising how to manage and deal with unforeseen financial events is essential for every owner-manager. The crucial elements of the financial decision-making process include (1) financial decisions – choice between equity or debt funds and associated costs; (2) investment decisions – choice of purchasing long term assets and (3) operating decisions to either reinvest profits back into a business and/or distribute profits back to the owners. In general, there are five fundamental principles to starting a new business: (1) evaluate your current financial conditions; (2) state your financial goals; (3) develop an action plan to achieve your goals; (4) implement your financial goals for your business, and (5) monitor and control the progress and introduce changes where necessary.

It is vital to plan for your business’s financial success and, when making decisions, always assess costs versus benefits and implied risks. Financial information has a significant impact on many business decisions. Financial statements report on the past, which is not necessarily going to indicate future prospects with 100% accuracy, but it can be very important in examining and evaluating your past financial decisions. In order to perform the financial statement analysis, every owner-manager needs to investigate past and current financial information of the business, industry benchmarks and competitors’ key financial indicators. The key financial ratios allow you to analyse the solvency of the business, liquidity of the business, the profitability of the business, ability to service short- and long-term debts, among others.

Your business’s success depends on many factors, and the economic environment in which your business operates creates the path for the future direction. At times of economic growth, there is an increase in business activity which is supported by strong consumer spending. During recessions, economy contracts and consumers tend to stay on the safe side and become very cautious with their spending plans. Economic indicators such as unemployment rate, inflation rate, gross domestic product (GDP), stock market index performance, exchange rates, government regulations and support suggest its future direction. Understanding and then applying in practice elementary economic indicators will help you think like an economist/financier when making financial decisions. The budgeting process allows the owner-manager to plan for the future and create strategic business plans in order to sustain business stability. This is the time for owner-managers to make sound business decisions related to revenue sources, spending, saving, investing, and, if necessary, pivoting towards new business ideas.

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