Six Financial Fundamentals for Small Business Owners

by Josh Biggs in Finance on 15th July 2021

To master any field or skill, it is vital to understand its basic principles first. This is the case in various areas ranging from architecture to engineering and from art to finance. As far as small business owners go, financial understanding provides them with a platform to build a successful business. However, unfortunately, most small business owners and entrepreneurs fail to understand these financial basics. 

That said, while a quality business degree will most definitely cover accounting and finance basics, it is through real-life experiences that owners get a better understanding of these principles. Not to mention, not every business owner has the time or the funds to enroll in an expensive business degree program.

Most small business owners have some basic understanding of personal finance management, including calculating net worth, creating a personal budget, calculating risk, and saving money for a retirement plan. The same applies to a small business. 

For example, expanding into new markets, making equipment purchases, and hiring more employees require business finance skills. While keeping this in mind, let us look at some finance fundamentals that small business owners need to know. 

Difference between accounting and accountancy. 

While both terms might seem similar on the surface, there are some differences in how both processes work. For example, accounting involves summarizing, classifying, and recording information. While, on the other hand, accountancy consists of the communication of gathered financial information to business managers, leaders, stakeholders (which includes auditing), accounting managers, and financial reporters.

While some business owners might know of such differences, they must understand that hiring a professional accountant will serve them better instead of handling everything themselves. In addition, these professionals know the subtle differences between accounting vs accountancy and the process involved in both, allowing business owners to see a clearer picture of their small business’s financial situation.

Understand the Legal Structure.

There are four main legal structures- LLCs(limited liability companies), sole proprietorships, corporations, and partnerships. That said, you should choose a legal system that best fits your business based upon liability risk protection, the number of owners, and potential tax benefits or consequences.

On the other hand, while operating your business under a sole proprietorship legal structure, you’ll be personally liable for everything related to it. For instance, you will have to file taxes as a corporate entity as a C corporation. However, each owner will also have to pay taxes on their earnings. 

Plus, you will have to file taxes as an individual. Of course, there are various pros and cons with every legal structure. So, it would be wise to involve an attorney or tax accountant before deciding on your business’s legal system. 

Learn how to manage cash flow effectively.

Cash flow is the beating heart of every business, be it large or small. A company might be highly profitable on paper, but that doesn’t mean that you will never have cash flow issues. A successful business owner manages the cashing coming in and going out of their business effectively. 

The cash flow cycle starts when you pay money to purchase inventory and add value to it. It then ends when you earn profits from the merchandise you sold. If this cycle contains few days, the more profits you’ll make and avoid borrowing. That said, numerous factors can affect the cash flow cycle, including;

  • The time it takes to collect payments from clients
  • The time you hold inventory before it spoils
  • The amount of money you borrow
  • The money you spend purchasing merchandise

To ensure all these factors work in your favor, you must develop a cash flow projection. It will allow you to avoid financial issues and enable you to hold on to enough cash to pay lenders, staff, vendors, and most importantly, yourself!

Understand how to read a business financial statement. 

A business’s financial report card consists of three financial statements – the cash flow statement, balance sheet, and income statement. The income statement ( or profit/loss statement) allows you to track profits, expenses, and income for a particular time. It is a record of your company’s operation and its ability to bring in profits, both vital for survival in the long term.

A balance sheet shows your business’s assets, liabilities, and equity percentages. It allows you to track any changes in your business’s financial situation and shows its financial strength when looking to secure loans.

Lastly, a cash flow statement allows you to determine the time it will take to earn back the cash you’ve spent on your business. It is vital to keep this time as minimum as possible to ensure you have enough money in the bank to pay everyone related to your business.

Understand the financial consequences of hiring employees.

The financial implications of hiring an employee go far beyond just your ability to pay their monthly wages. Therefore, it would be best if you found the answer to two questions before hiring someone new. Number one, how will hiring an employee help with increasing income?

Number two, how will it make your business more productive? Finding the answer to these two questions will allow you to determine if a new employee is worth the investment. Moreover, it will help you identify the right time to hire employees.

Understand the importance of funding.

While you can start some businesses with a shoestring budget, others will require a lot of cash. For example, buying brand new, out-of-the-box business equipment when second–hand options are available will use up unnecessary money, which could’ve been better utilized in purchasing inventory or improving marketing efforts. 

Therefore, putting your entire focus on expenses related to profit generation is vital to managing your business.

Every business expense should answer a simple question, ‘how will a particular purchase edge me closer towards breaking even and my business’s bottom line?’ Moreover, ensure that you set realistic projections. Most of the time, small business owners set unrealistic time estimates related to breaking even, which leads to overspending, etc. 

So, prepare yourself for the worse-case-scenario as it is a good backup plan when you run out of money and time while on the verge of tasting success.

Conclusion. 

If any of the financial fundamentals mentioned above are causing you to sweat profusely, perhaps now is the time to kick your financial knowledge into fifth gear and become a financial genius. However, if you think that finance is not your cup of tea, you could always hire a professional accountant or financial planner to take over such duties from your hands!

Categories: Finance