Finance Basics for Small Business OwnersKatherine Mines
There are some things you should know how to do as a business owner and leader. One of the most important–understanding your business’s finances. Some business owners feel that finances are not their strength so they shy away from that aspect of their business. But, this creates a vicious cycle—the less time you spend on the numbers the less you know about what’s going on with your money and the next thing you know things have gotten completely out of control and you’re going out of business.
Leadership Equals Financial Literacy
When you decided to start your business, you may not have expected that you would need to become so familiar with the financial side of things. You thought you’d be making big-picture decisions. You might even think it a good business decision to outsource the bulk of the finances and bookkeeping. Handing off the financial tasks to someone who is better at running the numbers isn’t necessarily a bad thing. In fact, you should definitely have a professional do your taxes (because business taxes are complicated!). But, as the business owner, you must be knowledgeable on what’s going on in your business and have enough financial literacy to keep an eye on the health of your company if you want to stay in business.
Know Your Numbers
No matter the reason you started your business, if you don’t know your numbers you won’t be in business for very long. If you know what’s going on in your business, you’ll be able to make better, more informed decisions. You have to know things like:
- Is your business losing money?
- What are your annual top-line revenue and monthly run rate?
- What’s your bottom line based on expenses and revenue?
- What the difference between your business’s income and profit?
- What’s your burn rate and is it sustainable?
Some of those terms might sound like Greek to you. To get to all of that information, you first have to start with these 3 foundational reports:
A balance sheet is basically a snapshot of a business’s assets, liabilities, and shareholders’ equity. Ideally, you should be looking at your balance sheet daily, that way you will be so familiar with it that you will notice immediately if something is amiss. Knowing your numbers is a discipline and a habit!
Some important things to ask yourself when looking at your balance sheet:
- What’s my cash balance?
- What’s the bank say?
- What accounts receivable are out there?
- What’s the inventory balance?
- What’s my next principal or interest payment?
Income Statement or Profit and Loss Statement
An income statement captures how much revenue was earned and expenses were paid over a specified time period and shows the profitability of the business.
The cash-flow statement allows you to see the money in and money out. It might seem like the same thing as the Income Statement, but it can actually allow you to see if your business generated or lost cash during the specific time period.
Successful Businesses Run on a Budget
One of the cornerstones of maintaining a financially viable business is setting and operating off of a budget. A budget gives you something to aim for and to measure success by. It can also help you:
- Keep expenses accountable
- Set goals and parameters
- Help forecast cashflow
- Help determine potential growth
Do you have a business plan? That could serve as your basic budget. Use historical data (such as last month’s profit and loss statement) to build your budget.
One great way to manage your business finances is by following the “profit first” principle. Business coach Mike Michalowicz takes the principle of profit and turns it upside-down. In his book, Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine, he explores the idea that by changing how you manage your business finances you can increase the chances of your business’s long-term success.
Michalowicz says that revenue minus profit equals what you have left to spend on expenses. Setting aside those profits first will ensure you have a viable safety net should you run into a worse-case scenario such as a lender recalling your loan. As you start to bring money into your business, you should immediately separate it into 4 different accounts:
Taxes: The first account should be dedicated to your business taxes. Leaving your taxes for last is a big no-no and a mistake too many business owners make. Taxes are not an optional expense or an area where you can trim fat. There’s no getting around it, you will have to pay them eventually. To avoid a big bill of penalties and fines later, set aside the money to pay taxes yearly, and “give to Caesar what belongs to Caesar.”
Your Paycheck: The second account you should create is one that’s used to pay yourself. After all, you are in business to make a living, and you have to make enough to fund your own personal expenses and lifestyle. According to the profit-first principle, you should always pay yourself before reinvesting profit to pay for expenses.
Profit: Establish another separate account for profit. This will function as a sort of savings account for your business. Pay this account before you pay for any other operational expenses.
Expenses: Maintain your existing business checking account for operating expenses. I know–it seems counterintuitive to leave expenses for last, but this idea is called profit first. The expenses account gets funded only after the first three accounts have been satisfied. Expenses are how your business is able to run and make money and Michalowicz says that by employing this method, you’ll quickly find unnecessary expenses that you end up avoiding, delaying, or cutting altogether. Difficult decisions might have to be made and processes streamlined but if the money isn’t there, you can’t spend it.
Tap Into Your Resources
No matter how many times you run the numbers, knowing the basics of business accounting is foundational to staying in business. If you feel you still lack the knowledge or confidence in knowing your numbers, get help! There are many ways you can brush up on your financial literacy skills, consider some of these:
- Take a basic business accounting course
- Hire an accountant to audit your books and check the health of your financials
- Link up with a mentor who has a proven and successful business
- Invest in accounting software to make getting intimate with your finances easier