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The Importance of Financial Planning for Small Business Owners

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Are you concerned about whether you need to close your business during this MCO period? For small business owners running SMEs, it’s arguably more important to be involved in financial planning as you must consider not only how it affects your personal finances, but also the financial health of your business and your employees in general. That’s a lot of responsibility. 

Based on SSM statistics, a total of 9,675 companies and businesses shut up shop during the first phase of the MCO from 18 March to 9 June 2020, while another 22,794 closed down during the recovery MCO (RMCO) phase from June to September 2020. What are the reasons for small business owners to make such a tough decision? Here are some possible reasons why:

Lack of crisis awareness

Many business owners may overestimate their business operating model. They tend to feel that a higher degree of effort put into their business leads to a higher degree of success. While this may be true, it doesn’t take into account emergencies and unforeseen circumstances like the Covid-19 pandemic. Without any backup or emergency funds in place, there’s only one possible outcome.

Misjudgment

There’s a common tendency for people to inaccurately assess the degree of risk in a risky situation. This happens mainly due to irrational behaviour and overconfidence in their personal judgement. Therefore, losses may occur due to ignoring the possibility of wrong information and hastily acting without performing their due diligence.

Lack of financial planning

During the MCO, many small business owners applied for loans to sustain their SMEs. Many may have used all their resources in order to start the business at the beginning. Thus, when business is not going well, they will need to find a way to raise funds to avoid going bankrupt.

Transformation of small business model

Across industries, both small and large businesses are accelerating digital transformation processes for long-term growth and profitability. Yet, there are businesses that remain untested in the face of digital challenges, with their digital transformation readiness remaining uncertain. As a result, these companies that cannot adapt to change will be knocked out of the business cycle.

So, what steps can small business owners take to prevent this? Planning ahead is key to ensure businesses can survive periods of uncertainty, with preparations made before it occurs. Regardless of economic conditions, business owners can take several precautions to mitigate risk:

Plan well for financial health

In football, strikers spearhead the attack but often have nothing to do with defending. Similarly, small business owners may be too focused on earning money and neglect other financial needs of the business. Financial planning is key to ensure good financial health, which allows you to focus on your core business without any concern since a strong financial base has already been built.

Separate legal entity

All transactions associated with a business must be recorded separately from other business or personal transactions. If records are mixed up with that of its owners or other businesses, the accounting information loses its usability – this is an issue that still plagues many family-owned SMEs today due to a lack of management. Many owners will feel that no matter how much they earn, it’s not enough for them to retire. By not recording business cash flow separately, they’ll never truly know how much their business can earn in comparison to their personal expenses.

Build up an emergency fund

Strong cash flow allows a company to have more flexibility in regards to business decisions and potential investments. Therefore, it’s very important to have an emergency fund in place to survive tough phases like the current MCO period. During this time, many SMEs have been forced to stop operations or close completely due to insufficient funds. However, businesses that were well-prepared have been able to sustain themselves and weather the storm accordingly. After all, “cash is king”!

Refinancing

Most people would like to settle their mortgages as soon as possible, and small business owners are no different. The feeling of being in debt is one that no one likes. In times of crisis, they may prefer to rely on overdrafts, credit cards, or term loans and personal loans that don’t require collateral. These liabilities may have a higher interest rate and a shorter payment term. For small business owners looking to tough it out, refinancing a home loan is an option as a longer payment term and lower interest rate can be negotiated compared to the loan facilities mentioned. Plus, you’ll end up with a lower monthly commitment!

Asset diversification

As mentioned earlier, “don’t put all your eggs in one basket”. While properties and other physical assets may be tangible, it doesn’t provide liquidity during periods of low revenue. Therefore, it’s important to diversify assets accordingly. Businessmen may select other investment vehicles such as REITs, share, commodities, bonds, collective investment vehicles such as ETF and unit trust, and also other regulated investment tools that have high liquidity and can be easily converted into cash.

In conclusion, it’s very important for small business owners to have a sense of urgency about their personal finances. With proper financial planning, you’ll be well-placed to face any uncertainty ahead and can survive black swan events without panicking.

About the author

Alex Teoh Teik Shiang (FAR CMSRL) is a FA Director, Licensed Financial Planner and Bank Negara Approved Financial Adviser Representative who is well-versed in advising business owners. He can be contacted at alex.teoh@yesfinancial.co

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