Without an understanding of financial management which includes everything from budgeting to balance sheets, a small business could be one of the 20% that fail during the first two years or one of the 45% that fail during the first five years according to data from the Bureau of Labor Statistics.
It is important for entrepreneurs to have a basic understanding of managing finances to optimize business performance and gain the insights needed to make sound business decisions. This is becoming more critical as small businesses navigate and work to survive during the COVID-19 pandemic, as a company’s finances equate to the health of the business.
Entrepreneurs don’t need a degree in finance to improve their financial literacy. Just like developing any other skill set, becoming financially literate requires a combination of theory and practical experience as well as knowledge of best practices. Entrepreneurs can increase their financial literacy by understanding some of the basics and leveraging technology to help manage the financial health of the business.
Learning how to budget is one of the first steps toward financial literacy. Budgeting, which can be done quarterly or annually, is detailed planning for how money will be allocated each month or each year. Putting a budget in place is of utmost importance as it can help track cash flow and business expenses as well as how much revenue is needed for operations and to keep the business growing. Budgets can also help monitor business performance and provide insights into the right timing for purchasing new equipment.
According to US Bank, 82% of businesses that fail are actually profitable but failed to manage their cash flow. A CB Insights analysis on the reasons why start-ups fail found that 29% cited running out of money as the cause for their demise. Cash is the lifeblood of any business. It is critical for entrepreneurs and small business owners to develop a strong understanding of cash flow which is essentially the movement of money into and out of a business. Accounts receivable represents money coming in from customers purchasing the product or service. Accounts payable is the money going out for fixed and variable expenses. Fixed expenses are payments for rent or a mortgage, monthly loan payments, insurance, etc. Variable expenses can include expenses such as marketing, utilities and office supplies.
This understanding is critical to making effective decisions about the business including pursuing business opportunities that make sense. For example, understanding business cash flow can help determine whether the company is in a financial position to take advantage of an opportunity to buy an overstock item at a deep discount. Having this acumen or financial literacy can ultimately help drive profit to the bottom line.
Income statements and balance sheets are the lifeblood of a business. It’s important that entrepreneurs learn to read and utilize these tools. Using these financial tools to develop a deep understanding of the financial health of their business will help entrepreneurs increase the long-term viability and success of their business.
Having clear visibility into the health of the business – knowing whether it is generating a profit, breaking even or operating at a loss – can facilitate smarter business decisions. Income statements, balance sheets and cash flow statements all paint a picture of the company’s financial condition to help entrepreneurs steer the course of their business and make smarter business decisions.
Becoming financially literate about the business can help entrepreneurs determine when it makes sense to use business credit. Business loans can be used to help a company grow and are often tied to the business owner’s credit history. Lending institutions will look at personal financial management to determine the viability of making a business loan. Entrepreneurs can help build their business’ credit scores by paying bills on-time, establishing lines of credit with vendors or suppliers and maintaining an on-time payment history, and checking credit scores for errors.
Learning about different business loan options will also improve financial literacy. There are many different types of small business loans including term loans, Small Business Administration (SBA) loans, business lines of credit and business credit cards to name a few. With the high demand of SBA’s Paycheck Protection Program amid the COVID-19 pandemic, eligible small businesses should apply sooner rather than later as the funding likely won’t come immediately and may run out. Entrepreneurs should research available options to determine the type of loan best suited to their business needs.
Entrepreneurs need to leverage available technology as much as they can. This allows them to increase efficiencies and maximize results.
Technology can provide entrepreneurs with the data and analytics they need to increase their financial literacy, make more informed business decisions and remain competitive in the digital economy. For example, cloud-based accounting platforms can connect into bank account and credit card transactions to track expenses and cash flow, providing a clear picture of financial performance to better inform business strategy. This data can also help small businesses track key performance indicators and benchmark their performance against competitors.
Cloud-based accounting software can provide a whole suite of tools to help business owners get ahead. Cloud-based accounting platforms allow small businesses anytime, anywhere access to financial data and information. This technology is often perceived by small businesses as solutions designed only for large enterprises. The fact is, cloud technology is becoming a fixture in a majority of business operations today to drive operational improvements.
Cloud-based bookkeeping and accounting subscription services are an affordable way for entrepreneurs to improve business operations by saving on infrastructure costs, gaining the flexibility to scale up or down with business conditions, and eliminating the need to keep up with the latest versions of software.
Technology solutions that automate accounting, bookkeeping and tax filing functions can give entrepreneurs more hours in the day to focus on higher-value activities. This technology does the monthly bookkeeping, which gives owners a monthly profit and loss and balance sheet. It also can keep companies IRS compliant and take care of their annual corporate tax returns. Business owners can see their revenue and profitability trends over time which can help them become more financially literate about the health of their businesses. Automating repetitive accounting and bookkeeping processes speeds them up and delivers improved accuracy and efficiency.
There are over 30 million small businesses in the U.S., and it is estimated that approximately 543,000 small businesses are started every month in this country. Many of these new entrepreneurs will face challenges when it comes to financial literacy. The good news is that entrepreneurs can learn this skill by gaining a basic understanding of fundamentals of budgeting, cash flow, financial statements and business loans and learning how technology can help them along in their journey toward financial literacy.