Many small business owners fear the money side of their business. This is a result of never really understanding how to keep track of it, and not knowing what the most important metrics are for tracking it. Some don’t want to face the financial truth about their company. “Once-a-year” accountants are not much help, since they speak in a jargon that small business owners do not understand. For their part, small business owners are embarrassed to ask questions for fear of looking stupid. Unfortunately, these actions often mirror what is going on in their personal lives.
Here are seven truths about money that every small business owner must know to be successful.
1. People Spend What They Have
Most businesses will spend all the cash they have available in their bank accounts in an effort to grow their companies. This obviously is not the best way to manage money in any situation. Alternately, money can be wasted if too much of it is freely available without its results being tracked.
Your action: Review your financial statements (i.e. profit and loss, balance sheet and cash flow) every single month. Make sure that you understand what each number means for your business and what actions you need to take as a result. Get help from a trusted advisor. Determine if each expense or investment is critical to the growth of the company and what that expense or investment is expected to return.
2. Cash Is King
Revenues and profits really do not ultimately matter. The key to financially building a strong company is to monitor its cash flow. This is because all employees and vendors are paid with only cash, not the sales or the profit that the company reports on its financial statements.
Your action: Does the business have more or less money at the end of the month? An easy way to do this is to check the company’s bank statement for the first and the last day of the month. Which is greater? Which activities during the month increase or decrease cash flow? Higher receivables, more inventory and lower payables all consume cash. Remember that successful companies build their cash balances over time.
3. Budgets Do Work
Business budgets can work only if they are utilized correctly. They are a fundamental way to track expected revenue and expenses against actual performance. They answer the question: “How is the company doing?” Ideally, budgets should only be set once a year, and then changed only every six months.
Your action: Set annual revenue and expense budgets based on previous performance and expected results from new investments or changing marketing conditions. Track progress monthly, but change only bi-annually. Don’t hastily judge yourself for being ahead or behind on the budget forecast. Treat any unexpected result as valuable information to learn from.
4. Debt Is Not Always Bad
Most small business owners use debt for the wrong thing. It should be a tool to plug short term operational losses. Debt should be used to make long term investments or make up for highly predictable—and temporary—seasonal revenue short falls. Owners need to calculate the repayment burden that any debt puts on the business as part of its efforts to grow and invest in the future.
Your action: Classify all your business debt as short- (less than one year) or long-term. Identify both the exact profit you expect to make on the borrowed money and the time you expect to make said profit. Calculate an estimated return. If you have many debts, start with those with short-term repayment windows and debts with a low rate of return from the initial investment.
5. Business and Personal Credit Scores Matter
The company’s ability to manage its cash flow can depend on if it can borrow from a bank or get payment terms from its vendors. Creditors will look at both the business’ and the owner’s personal credit scores. The higher the score, the more likely terms will be granted. Banks will give a lower rate of interest for a higher score.
6. Save for Retirement Now
Every small business owner needs to save for retirement. No one has the luxury to start a year—or ten years—from now, regardless of their age. In addition, no business owner can depend on the sale of their company to fund their retirement. Don’t forget that investing in retirement now will also likely lower this year’s tax obligations.
Your action: Set up a 401(k) or SEP in association with your company. Make contributing the maximum income amount a priority every year. Invest in financial products that provide long-term returns. Remember that compounding interest is a principle that still works.
7. Set Up an Emergency Business Fund
All businesses have market cycles. In some years, business is good. Sometimes, sales are weaker. Successful companies survive those ups and downs with an emergency fund that gets them through lean times.
Your action: Define what constitutes an emergency in your company. Typically, a sales drop of 25% or an unexpected expense increase of more than 20% constitutes one. Does your company have enough in the fund to cover 35% of fixed operating expenses for three months? Grow this fund to a six month cushion over a two year period.
Do you understand the truth about money? What are the successful financial principles you live by? Barry Moltz helps small business owners get unstuck. He is the author of 5 books on small business, speaker and radio talk show host. He can be found at www.barrymoltz.com.