Managing finances is the lifeblood of any small business. Keeping a keen eye on your financial situation is paramount whether you’re just starting or have been in the game for a while.
Many small business owners wear multiple hats, including that of the accountant. And, as your business grows, bringing in a professional accountant is advisable. However, even if you do, you should always stay close to your finances.
This article will explore the essential financial concepts that can help you make informed decisions, reduce financial stress, and drive your small business towards greater flexibility and growth*.
One: Revenue vs. Profit vs. Cash Flow
Understanding the basic principles of finance is crucial.
One of the fundamental distinctions in finance is understanding the difference between revenue, profit, and cash flow.
- Revenue: This is the total income your business generates from sales of products or services. It’s often called the “top line” because it’s the total amount before any expenses are deducted.
- Profit: Profit is what’s left after subtracting all expenses (such as operating costs, taxes, and interest) from your revenue. The difference between ‘Gross Profit’ and ‘Net Profit’ can be found below.
- Cash Flow: Cash flow refers to the actual cash that moves in and out of your business. It can differ from profit because it considers when payments are received and expenses are paid. Positive cash flow is crucial for meeting day-to-day expenses and seizing growth opportunities.
Other terms that you should familiarise yourself with are:
- Gross Profit: Gross profit is the revenue after deducting the cost of goods sold. It reflects the essential profitability of a business’s core operations.
- Net Profit: Net profit, or the bottom line, is the profit left after all expenses, including taxes and interest, have been deducted from revenue.
- Profit Margin: This is the percentage of revenue that represents profit.
- Break-Even Point: This is the level of sales at which a business covers all its costs, and neither makes a profit nor incurs a loss.
- ROI (Return on Investment): ROI measures the profitability of an investment.
Top tip: If you’re working with an accountant, it’s critical you understand the information they provide. Don’t be afraid to ask your accountant to explain the numbers in a way you understand. A good accountant shouldn’t patronise you and takes the time to ensure you know the financial situation of your business. While your accountant should have your best interests in mind, they cannot make business decisions for you and are characteristically risk-averse. Therefore, a deeper understanding of the numbers will allow you to make informed business decisions.
Two: Budgeting and Financial Planning
Many small businesses run on a day-to-day basis and only analyse their expenditure at the end of the quarter or financial year. However, creating a budget can help you plan your finances, set financial goals, and allocate resources efficiently.
Ultimately, there are so many benefits to budgeting. Not only can they allow you to track your income, expenses, and cash flow, but psychologically, budgets can make spending money on necessary expenses easier, as the money is already an agreed expenditure and allocated for a purpose. They can also help you identify areas where you can save money or invest for growth.
Three: Check your financial pulse
Regularly reviewing your financial statements, including the income statement (or profit and loss statement), balance sheet, and cash flow statement, will make you much more agile and help you grow/avert disaster much more quickly.
- Balance Sheet: A balance sheet is a financial statement that shows a business’s assets, liabilities, and equity at a specific point in time. It provides a snapshot of the business’s financial position.
- Income Statement (or Profit and Loss Statement): An income statement summarises a business’s revenues, costs, and expenses over a specific period, typically a month, quarter, or year. It shows whether the business is profitable during that time frame.
- Cash Flow Statement: This statement tracks the inflows and outflows of cash during a specific period and categorises them into operating, investing, and financing activities.
These documents provide insights into your business’s financial health, performance, and liquidity. They’re essential for making informed decisions and assessing your business’s financial well-being.
It would help if you made the time to have small internal account meetings each week and a larger one each quarter with your accountant. Regular check-ins will identify minor course corrections to help take advantage of new opportunities and avert imminent disasters.
Top tip: Separating your financial role from the business’s daily operations is essential. Daily, you might be on top of the invoice value (revenue); however, this information alone doesn’t provide you enough insight into the business’s financial situation to make informed decisions.
Four: Separate Business and Personal Finances
To maintain financial clarity, it’s crucial to separate your business and personal finances. Open a dedicated business bank account and use it exclusively for business transactions.
This separation simplifies financial record-keeping, ensures compliance with tax regulations, and helps you accurately gauge your business’s financial position.
If things do get inadvertently connected, make sure you compensate yourself accordingly. For example, be sure you expense business costs so you’re not personally out of pocket and can accurately track business expenses.
Five: Investment and Financing Options
Keeping on top of your business finances will allow you to explore various financing options for your business, such as loans, lines of credit, or investments from external sources.
For example, taking advantage of credit options can keep you liquid (cash flow). However, carefully consider how each choice aligns with your business goals and financial capabilities and always discuss things with your accountant.
How ETC can help
Mastering finance is not just for accountants; it’s an essential skill for every small business owner.
Understanding revenue, profit, and cash flow, budgeting, and reviewing financial statements are critical steps. These principles provide the foundation for making informed decisions, optimising your business’s financial health, and ultimately achieving flexibility and growth. By gaining control over your finances, you’ll be better equipped to navigate challenges and seize opportunities, moving your small business toward long-term success.
If you need help understanding how best to manage your business finances, please get in touch.
If you are new to ETC, why not contact us for a free new business review? We’ll spend two hours with you, giving you professional coaching and will leave you with actions for immediate implementation.
– Please note –
* Any financial information within this article is for general informational purposes only. We are not financial advisors, and the content in this article should not be considered professional financial, legal, or investment advice. Please consult with a qualified financial advisor, accountant, solicitor, or other professional before making any financial, legal, or investment decisions. It is essential to conduct your research and seek professional guidance tailored to your specific circumstances.