Financial stability. Passion. Talent. Work-life balance. The reasons for wanting to start a small business vary for everyone almost as much as their reasons for actually taking steps to make it happen.
After the risk has been taken and the proverbial leap of faith has been leapt, those reasons are even more important. Remembering your “why” as a small business owner is something that gets you from email to email and sales call to sales call.
Yet there is something that most small business owners may forget to account for along the way: finances. Take, for example, the work-from-home mom who is running a freelance writing business. Or the couple who just opened a small dental practice. Or what about the graphic designer starting up a career in social media marketing?
In these, and so many other cases, entrepreneurs are doing what they’re passionate about. Small business owners are living their dream. You are living your dream.
But that doesn’t change the fact that in this new business you are not only the visionary, but often you are also the accountant and the vice president of sales and the human resources person.
What you decide to do about that is ultimately your choice, but it doesn’t change the truth. Having at least a basic understanding of the financial terms involved with running a small business may not seem fun at first. It may even be scary or intimidating. But it can make or break your business in the long run.
Here’s a fundamental rundown of some of the things you should know:
Profit and Loss Statement – Used to summarize the revenues (money earned) and expenses (money spent). Often abbreviated as the P&L statement, this report demonstrates the company’s financial standing during the selected period of time. For example, if you run a P&L for January 2017, you will see the money you earned and spent in January 2017 ONLY. If you want to view other periods of time, you need to select the date range for which you wish to see.
Balance Sheet – Used to summarize the assets (what is OWNED), liabilities (what you OWED), and equity (company’s WORTH). Unlike the P&L, the balance sheet serves as a snapshot of a company’s financial picture at the time it is produced. For example, if you run a balance sheet as of 2/20/2017, you will see RIGHT NOW what your company owns, owes, and is worth. These values change daily, and are living, breathing numbers. They show the life force of your business.
Cash flow: How money flows in and out of a business during a period of time. You are able to produce a Statement of Cash Flows as well. The cash flow statements are broken down to include operating, investing, and financial components for the period in which you pull the report. Essentially, your cash flow is a marriage of the Balance Sheet and the P&L. You may have expenses for which you haven’t paid (Accounts Payable) or you may have income for which payments have yet to be received (Accounts Receivable), and other examples. Cash is king, so knowing exactly where your cash is going and coming, and managing it through slow times of the year, is pertinent for any small business owner to understand.
Gross margin: The difference between revenues and cost of goods sold (COGS), divided by revenue, expressed as a percentage. Showing you how much of your sales price is consumed by the cost to produce. This is an important figure to know since it can help a small business owner determine the percentage that is actually being earned in exchange for goods and services. Once you have a basic understanding of what gross margin is, you may be empowered with the insight you need on how to increase it; by either reducing costs or increasing prices.
Fixed and variable costs of doing business: The costs associated with living the dream of being a small business owner generally break down into either fixed or variable costs. Fixed costs are those that remain static regardless of production output. These include things like rent, depreciation, insurance, property taxes, and salaries. Variable costs, on the other hand, increase or decrease based on the company’s production. As production increases, often so do the number of hourly wages, utilities, member-based subscriptions, and materials used in production.
Monthly operating expenses: Generally thought of as the recurring cost of operating a business. These are the expenses which will be required to be paid regardless of if sales are made, and they can be a combination of fixed or variable. Knowing your monthly operating expenses is essential to managing your business’ budget year-round.
Return on investment: Everything you do for your business is an investment and you want to make sure you receive a Return on Investment (ROI). Some actions and decisions are immeasurable, while others can be calculated by evaluating the cost over benefit. As a small business owner, you need to evaluate your decisions quickly to determine if you are gaining a positive ROI. If you aren’t, you need to cut that action. For example, it takes you 10 hours a month to manage your accounting and your billable rate per hour is $60. That means it costs you $600/month to process your accounting. Can you find a bookkeeper to handle it FULLY for less than that? If you can, do it. If you can’t, keep it until a better opportunity comes along. Always make sure you are gaining a positive ROI. In many cases, the outsourcing of tasks can be a very profitable investment for business owners, since it allows them to do what they went into business to do.
For you, it may have been financial stability. Or passion. Or talent. Whatever your reasons are for making your dreams a reality, there is no need to fear the finances.
The most important thing you can do is remember your “why,” and ask for help when you need it. Because this is your passion, your business, your life and your money. Use it wisely.