Financial Literacy and Long-term Success
There is no shortage of great advice out there for entrepreneurs and small businesses. Everything from tips on hacking growth to perfecting your pitch, yet the success rates for small business is still low. The reality is that being an entrepreneur requires a very broad and diverse set of skills in a number of disciplines.
While I am not suggesting any singular discipline will determine the success or failure of your business, you need to recognize that there are many factors at play. You need the good idea and the brilliant execution just as much as you need to have the ability to sell. What I am suggesting is that a lack of certain skills could increase your chances of failure.
One of these skills is something very basic: financial literacy. Here’s why I think it’s critical to your success as an entrepreneur, even if you hire help.
What do I need to know?
As an entrepreneur, you have the option of paying experts to help in various financial capacities and there are plenty of experts out there so you can take your pick of who you connect with best. Having said that, I recommend that you still need to understand the basics of reading and understanding your financial statements and forecasts. If you don’t have this foundational understanding, you should ask your hired help to explain it to you until you understand. Don’t be intimidated, accounting and finance can be understood at a working level by almost anybody.
The basics: knowing when you’re succeeding (or failing)
As an entrepreneur, having some financial literacy will allow you to understand where you’ve been, where you are and where you are going. There are three things at play here and you need to understand how they work. Here is what your basic financial statements should be able to tell you.
A Statement of Operations, sometimes called the Income Statement, tells you about what has already happened and your businesses performance in the past. The Statement of Operations will tell you how much in sales you made and how much it cost (your expenses) to make those sales, with the bottom line being your profit. This is used to track a certain period of time in the past, such as the last month, quarter or year. You should use this statement to measure your past performance and gauge how business is going, including comparing it to different periods of time to see longer-term progress. If you are profitable that’s great, and if not, what are you going to do about it? Can you increase your sales, reduce your expenses, price products to create a larger margin and so forth. Where are your highest margin sales coming from? Where are your expenses too high? Being able to answer questions like these will help you make useful decisions to get where you want to go.
Next, the Statement of Financial Position, sometimes called the Balance Sheet, tells you where you are at any given moment of time. It tells you about everything you own (assets) and everything you owe (liabilities) and then what’s left over (equity). From this statement, you can see what the cash situation is in your bank account, how much people owe you and how many long-term producing (capital) assets you have. A closer look will reveal how much you owe people, specifically how much will be due soon and any longer-term debts you have. This statement will give you another aspect of the health of your business and can help you assess your ability to pay debts or expand.
Finally, looking into the future, you should have some idea of what’s ahead. You can use your accounts receivable as an indicator of the immediate cash coming in and you’ll probably need to use a model based on how your business operates to forecast your longer-term revenues and expenses. I’ve written before about various tips for financial forecasting that you can use to get started. Similar to the other statements mentioned previously, looking into the future can provide a good indicator about the health of your business, but you have to be realistic. These figures are what you’re working towards and will help you understand how your business makes money and where it could do better.
Knowing the above three statements, how they work and how they flow together is a key success factor for entrepreneurs. Knowing where you’ve been, where you are and where you are going will help you recognize the first signs that things are working (or not working) with hopefully enough time to adjust course as needed.
Bonus: making investors and lenders comfortable with your business
If you are ever planning to borrow money for your business or to solicit investment, you’ll likely be asked to speak to information in part, or in whole, about the above financial statements and how your business operates and makes money. By understanding how they work together, you not only benefit your business but you’ll give bankers or investors more confidence that you know what you’re doing.
Photo Copyright: Andrey_Popov