Members of Forbes Finance Council share financial concepts small-business owners need to get a firm grasp on. Image By VentureBeat
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Here are 14 financial concepts that small business owners must understand to ensure they have basic financial literacy to run their businesses successfully.
Running a small business takes a lot of time and energy, and it’s wise for entrepreneurs to hand off high-impact tasks they aren’t especially knowledgeable about to outside experts. Still, while small-business owners may opt to outsource their financial functions, they need to “speak the language” if they’re going to fully understand their experts’ recommendations and accurately communicate their business situation.
So what financial concepts should a small-business owner have a firm grasp on to work effectively with their advisor—and keep themselves out of potentially sticky situations? Below, 14 finance experts from Forbes Finance Council share accounting and money concepts they believe every business owner needs to know.
1. Basics Of Income And Expenses
All business owners need to understand the basics of income and expenses. If you as an owner don’t understand how you make or spend money, you are at a significant disadvantage. An owner needs to balance fiscal responsibility and the growth of the business. This is lost if your business is driven solely by an outside financial firm that does not truly understand or share your company vision. – Joseph Orseno, Tiltify
2. Income Statements Versus Cash Flow Analyses
It’s important to understand that your income statement—or, as it’s widely known, your P&L—is not an indication of the liquid health of your company. While the bottom-line figure of your P&L could be in the millions, the best way to make short-term financial decisions is to request and review regular, current and projected cash flow analyses, which can be as simple as a 10-line Excel spreadsheet. – Lilit Davtyan, Phonexa Holdings, LLC
3. Operating Cash Flow
Operating cash flow (OCF) is really the lifeblood of any business. It tells the real story of how your company is performing and, even more importantly, the length of your runway. In general, a company should aim toward either a positive OCF that will fund initiatives or a negative OCF that funds high growth and aligns to an adequate cash runway (target 12-plus months as a general rule of thumb). – Zack Cook, Keyfactor
4. Gross Sales Versus Net Profits
Business owners need to understand that gross sales never equals net profits. Too often, small-business owners focus so much on sales that they forget to equally focus on the cost side of their business. Understanding each line item of expense, knowing industry averages for each line item and having adequate cash at any given time is absolutely critical to a healthy and well-run business. – Mike Hardwick, Churchill Mortgage Corporation
5. Reading A Balance Sheet
Most entrepreneurs can look at a balance sheet and understand the basics of what’s there. But they often don’t know how to spot line items to explore more. Owners should listen to that voice in their head that says, “Wait, that seems a bit off to me.” Outsourcing can be great. But no one knows more about the business than the owner. Trust but verify by knowing which details to dig into. – Todd Sixt, Strait & Sound Wealth Management LLC
6. Unit Economics
Small-business owners need to be able to drill down to basic finances, which is where unit economics comes in. The idea is that you should know the expenses and revenues associated with a specific product or business unit. Small-business owners who understand their unit economics will also better understand their businesses and will be taken more seriously by partners or investors. – Dan Henry, Green Dot
7. Return On Equity
Return on equity is a good accounting concept to understand because it can be used to determine whether you should continue to invest in your own business or elsewhere. Every investment, whether internal or external, has an opportunity cost. We need to consistently rate our performance—our return on equity—against what we can earn by investing in the stock market. – Oliver Sabga, Term Finance
8. Cost Of Goods Sold
Business owners need to completely and accurately understand their cost of goods sold. If there is not a solid understanding of how much it costs to make your product or do your services, then you do not know how much you have left over to cover overhead expenses. Costs that are frequently not thought of include commissions or brokerage fees, packaging labor and materials, and even idle warehouse storage time. – Marjorie Adams, Fourlane
9. Benefits’ Impact On Finances
Don’t overlook how benefits impact your finances. Leveraging the financial power of a health savings account (HSA) program is a must. By adding an HSA program to your benefits offering and providing employees an easy way to make pretax HSA contributions through payroll deductions, you lower your own and your employees’ FICA tax liability and directly save 7.65% on all pretax employee contributions. It’s a true win-win. – Tom Torre, Bend Financial
10. Accounts Payable And Accounts Receivable
Cash is king for small businesses. Investing in digital tools to help you with accounts payable (AP) and accounts receivable (AR) will give you the transparency needed to see your cash flow. One rule of thumb: Stretch out the payables as long as you can and pull receivables in as quickly as possible. – René Lacerte, Bill.com
11. Working Capital
You should keep a close eye on working capital—it’s the money that keeps your business operating, so you need to make sure that you have enough. If you can’t get enough working capital because of seasonality or other external factors, then you can get loans. In that case, make sure your working capital ratio is between 1.2 and 2 to signify a healthy business to lending companies. – Ryan Rosett, Credibly
12. Cash Versus Accrual Accounting
It’s essential to understand cash versus accrual accounting and how your company is set up so that both can be maximized. If your company is set up on an accrual basis—as most government contractors are—it’s important to understand that a net profit at the end of the year does not necessarily indicate a large tax bill. Understanding this difference can help a business owner best strategize for taxes and annual goals. – Kelly Shores, GCubed, Inc.
13. Tax Liability
If a business is already cash-flowing, the owner needs to understand their tax liability. This can vary from entity to entity based on structure, but at the end of the day, if my business is already profitable, I want to understand how much I’ll owe in income tax and why so that I can do everything possible to reduce that number while still expanding the business or my personal assets. – Jerry Fetta, Wealth DynamX
14. Negotiating Payment Terms
You need vendors, and vendors need you. Don’t just take what they offer. Based upon how much you’re buying and any seasonal issues, negotiate terms that allow you to smooth out cash flows so that you don’t get caught dealing with huge payments that might come due at inopportune times. Most vendors have some flexibility, but if you don’t ask, you don’t get. – Chris Tierney, Moore Colson CPAs and Advisors
Article Credit to Forbes.com.
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