Assess Your Current Financial Position
To start building or reinforcing your business’s financial foundation, you first need to look at where your business is today. Below, we list the initial steps you should take to get a solid understanding of your business’s current financial position.
Bookkeeping and Financial Statements
You can’t determine your current financial situation if your bookkeeping is not up-to-date and you don’t have your financial statements to review. Your first step to building a solid business financial foundation is completing your financials. Regardless of where you are at, make it a priority to get your bookkeeping completed and your financial statements prepared.
Financial Statement Analysis
Once your bookkeeping is up to date and your financial statements are prepared, you’ll have an accurate picture of your business’s financial health. Let’s review the three main financial statements.
Income Statement
Review your income statement and confirm your business has a healthy gross and net profit, whether they are growing or falling year-over-year, and whether your direct and overhead expenses seem reasonable. The most important part of an income statement analysis is to know how cash is coming into your business and how it’s leaving.
Balance Sheet
Review your balance sheet to determine whether your business is financially healthy and operating efficiently. A few questions to ask yourself when reviewing your balance sheet are:
Do you have enough cash on-hand to manage upcoming expenses?
Is your company liquid, meaning in addition to cash, how fast can you turn current and long-term assets into cash?
How fast are you collecting on accounts receivable, and how many days does it take you to turn over inventory?
Are you paying your accounts payable early, on-time, or do you pay late?
Cashflow Statement
Review your cashflow statement to understand how much cash your business is creating. Having a positive or high net-income is great, but your business runs on cash and you need to know how your business creates cash and when you’ll receive it.
While each section of a cashflow statement is important, pay close attention to cash generated from operating activities, as this represents your core business. If your business isn’t generating sufficient cash from operating activities, it won't be long before you’re in trouble.
Analyze Spending Patterns
The closest hanging fruit to pick when building a solid financial foundation is to analyze expenses and spending patterns. Categorize business expenses into three categories:
Essentials - costs you must incur to earn revenue and keep your business going. Think costs of goods sold (COGS) and human resources directly attributed to earning revenue.
Discretionary spending - spending that isn’t directly attributed to earning revenue. Think overhead such as office space (do you really need 4000 sq?), company golf games, and planning retreats in tropical locations.
Investments for growth - These are costs that are intended to help the business grow, such as marketing activities, advertising, or a new piece of equipment.
Create a Comprehensive Business Plan
There’s a business saying that if you don’t know where your business is going, any road will get you there. This means you need to set finite business goals and identify the path that will allow you to achieve them.
Your business plan should clearly identify your business model, target market, competitive advantages, and how you’ll attract customers. You will also have financial projections on how much revenue you’ll earn, when, and how much it will cost you to earn the forecasted revenue.
Develop a Budget That Works for Your Business
To create a realistic budget for your business, you’ll start by estimating income sources based on past revenue, market trends, and sales forecasts. You will then identify fixed costs, such as rent and salaries, as well as variable costs that may include marketing and office supplies. Lastly, determine a reasonable amount for unexpected costs to include in a contingency account.
Use accounting software or spreadsheets to track expenses and revise the budget to reflect actual performance and any new information that becomes available. New information requiring a budget revision may include unexpected equipment maintenance costs, increased business insurance premiums, or costs associated with more staff needed than originally planned.
Monitor Cash Flow Regularly
Budgets aren’t effective in helping you manage your business and cash flow if they are not monitored and managed throughout the fiscal year. Here are some quick tips to get the most out of your budget.
Use bookkeeping software or spreadsheets to track expenses against the budget.
If you’re trending higher or lower in specific budget items, determine why and make necessary changes.
If the budget items trending higher or lower are anticipated to remain at these unplanned levels, re-forecast your budget for the remainder of the fiscal year so you know how much cash you’ll need to run your business.
Build and Protect an Emergency Fund
Businesses need an emergency fund to manage unexpected expenses and maintain their operations. These unexpected expenses could be due to economic downturns, legal issues, or equipment failure.
To create an emergency fund, start by putting aside 10% of your business revenue into a separate account not used for regular business expenses. Over time, the goal would be to have enough saved to cover six months worth of operating expenses.
The key to a successful emergency fund is to never use it unless it’s for an emergency and never to dip into it for short-term cash flow constraints. Why? Because it won’t be long before the emergency fund is completely depleted and the business has no financial buffer for emergencies.
Reduce and Manage Business Debt
It’s natural for a business to take on debt to fund its growth as it may not generate enough income and cash to pay themselves - at least early on. However, debt can quickly become a burden if not managed effectively.
It goes without saying that businesses with significant debt loads need to find ways to reduce their debts to more manageable levels. But how? They can do this by saving cash by reducing unnecessary expenses and generating more cash through increased revenue.
They should also look at paying off high-interest debt first and consider consolidating their debts into a consolidation loan where the interest rate is often lower. Lastly, lenders may be open to adjusting debt repayment plans to more manageable levels.
Avoid Overreliance on Credit Cards
Businesses shouldn’t use credit cards to fund their business growth as they are typically the most expensive form of credit. While certain situations may require a credit card for a large payment, they are best used for everyday business expenses, and paid off in full each month so no interest expenses are incurred. Healthy credit card use also comes with the perk of cashback and other rewards.
Consider using other less expensive forms of credit to fund your business's growth and operations, such as business loans, lines of credit, and other alternative forms of financing.
Invest in Financial Education
Business owners and managers must invest in their financial education. While this education and training may cost money and take time, it helps provide the skills to manage each business area more effectively.
Consider training courses offered online or through your local college. If you're interested in learning more about a specific financial topic such as investing, visit your local library or bookstore and pick up the latest book.
Leverage Professional Help
Business owners and managers can’t know and do everything for their business. They need to surround themselves and use experts in certain important areas. Specifically, it’s important to use:
Accountants: to ensure bookkeeping and financials are in order.
Lawyers: Contracts and commitments are well understood and the business is legally protected.
Tax Strategists: Ensure tax strategies are optimized so the business pays an optimal level of tax.
Business Consultants: to help evaluate and optimize operations.
Risk Management and Asset Protection
You need to make sure your business is protected against foreseen and unforeseen circumstances. Below are three areas to help protect your business as you build it:
Business insurance: protects your business against accidents and events outside of your control.
Diversified Revenue Streams: Don’t put all your business's success in the basket of one revenue stream and branch out to other revenue-generating activities.
Asset Management: Protect both your tangible and untangible intellectual property by having solid management procedures and registered trademarks and patents.
Regularly Review and Adjust Financial Strategies
Financial plans aren’t meant to be written, filed away, and reviewed after the results of the next 12 months have been realized. It should be reviewed at least quarterly and financial strategies should be adjusted as needed given any unforeseen changes, including both opportunities and challenges.
Track Progress Against Goals
Monthly financial reporting of revenues, profit margins, and expenses is critical to stay on top of the business’s finances. Businesses should review the financial results for each month and evaluate if they are still on track to meet their goals and objectives for the year. If they aren’t, then it flags the business to make adjustments to its business course to get back on track.
The Role of Long-Term Financial Planning
Long-term financial planning can often get relegated to whenever a business owner and manager can find the time. However, long-term planning is critical to ensure the business ends up where it ultimately wants to go.
Most importantly, long-term financial planning helps ensure alignment between short-term and long-term goals. If it doesn’t, it flags to the business that it needs to revisit its financial plan to ensure each milestone and goals are aligned and will ultimately get the business to its desired destination.
