How to Manage Finances in a Small Business

I. Importance of Financial Management for Small Business Owners

While most business owners are experts in their line of business like providing a product or service, it does not usually translate into efficient financial management. Especially if the business was started with bootstrapping operations, then small business owners need to develop business financial management skills to effectively manage their finances. 

Learning how to manage finances in a small business helps business owners effectively manage their cash flow, track their business expenses, monitor income and ensure there is enough liquidity to cover their business operations. We will now look at the key business financial terms and what it takes to evaluate the financial strength of a small business

II. Assessing the Financial Landscape

A thorough financial analysis MoM helps to assess your small business finances, make informed decisions regarding investments, gain insights into liquidity and manage risks efficiently. 

Such an analysis also aids in setting realistic goals, developing strategies, and maintaining transparency with stakeholders

 Conducting a financial analysis

The key components of financial analysis include examining financial statements, assessing financial ratios, analysing cash flow, and evaluating key performance indicators (KPIs). By reviewing and analysing these statements, you can assess profitability, solvency, and liquidity and make informed decisions regarding investments, financial planning, and resource allocation.

Here are the three main financial statements that you need to prepare for your small business.

Income Statement – An income statement is a financial statement that shows you the company’s income and expenditures. It also shows whether a company is making profit or loss for a given period.

Balance Sheet – A balance sheet is a financial statement that contains details of both a company’s assets and liabilities at a specific point in time.

Cash Flow Statement – A cash flow statement tracks the inflow and outflow of cash into your small business at any point of time.

Together, these three statements help you evaluate the financial health of your small business. 

Identifying key financial metrics

By comparing key financial ratios, such as profitability, liquidity, and solvency ratios, you can gain valuable insights into performance and make informed decisions. Let us understand each of these ratios.

Liquidity Ratio – A liquidity ratio is used to determine a company’s ability to pay its short-term debt obligations.

Profitability Ratio – Profitability ratios, such as gross profit margin and return on investment (ROI or rate of return), measure your small business’s ability to generate profit from its assets

Solvency Ratio – A solvency ratio measures how well a company’s cash flow can cover its long-term debt.

Together these ratios evaluate profitability, liquidity and the capacity of the small business to meet short and long term obligations. 

III. Creating a Budget and Financial Plan

A financial plan is a document that details the current financial circumstances of the small business as well as details strategies to achieve those goals. A financial plan should essentially answer these 3 questions about how you build your business.

• How will the business make money?
  
• What does the business need to achieve its goals?
  
• What is the business’s operating budget?
  

Here are the  steps to create a financial plan for your small business.

Create a Strategic Financial plan

Before looking at any numbers, a strategic plan focuses on what the company wants to accomplish and what it needs to achieve its goals. Will it need to buy more equipment or hire additional staff? How will its goals affect cash flow? What other resources are needed to meet its goals? A strategic financial plan answers these questions and determines how the plan will impact the company’s finances.

Create Financial Projections

Create financial projections for your business based on anticipated sales and cost forecasts. These projections look at the business’s goals and estimate the costs needed to reach them in the face of a variety of potential scenarios, such as best-case, worst-case and most likely to happen.

Planning for Contingencies

Planning for contingencies is about preparing for unexpected situations in your business that could have a negative impact on your finances. It involves using information from your cash flow statement and balance sheet to create backup plans for worst-case scenarios. For example, you might keep some extra money saved up or have a line of credit available in case you experience a slowdown in cash coming in.

Monitor and Compare Goals 

Monitoring and comparing goals is a crucial practice for businesses to track their progress and make informed decisions. By regularly analysing actual results in the cash flow statement, income projections, and relevant business ratios, businesses can assess how closely their real-life outcomes align with their initial projections. This ongoing evaluation allows them to identify any discrepancies or deviations from their goals.

Also Read: 19 Profitable Small Business Ideas for Working Professionals

Learn Top Tips on How to Manage Finances in a Small Business

Pay Yourself

As a small business owner, it’s important to pay yourself for your work and contributions to the business. Neglecting your own compensation can have negative consequences. Alexander Lowry, a professor and director of the Master of Science in Financial Analysis Program at Gordon College, emphasises that business owners need to recognize their role in the company and compensate themselves accordingly.

Consider the following steps:

1. Separate Personal and Business Finances: Establish a separate business bank account and track income and expenses separately to maintain clarity between personal and business finances.
   
2. Determine Reasonable Compensation: Consider industry standards, your role and responsibilities, the financial health of your business, and your experience and expertise when determining a fair compensation amount.
   
3. Seek Professional Guidance: Consult with accountants or financial advisors to understand tax implications, legal requirements, and how to structure your compensation.
   

By paying yourself, you acknowledge your value as a business owner and ensure both your personal and business finances are in order. Striking a balance between reinvesting in the business and compensating yourself appropriately is crucial for the success of your small business.

Invest for Growth

Investing for growth in a small business involves allocating resources strategically to expand and improve the business. Edgar Collado, the chief operating officer at Tobias Financial Advisors, emphasises the importance of setting aside money and exploring growth opportunities as a means of ensuring the long-term success of your business.

To invest for growth:

1. Identify Growth Opportunities: Evaluate potential areas for growth within your industry or market. Consider market trends, competitor analysis, and customer feedback to identify viable opportunities.
   
2. Develop a Growth Strategy: Create a clear strategy outlining how you will pursue growth. Set specific goals, define the steps needed to achieve them, and establish a timeline.
   
3. Allocate Resources Wisely: Determine the financial resources and assets necessary to execute your growth strategy. Prioritize initiatives that will have the greatest impact on achieving your growth objectives.
   

Edgar Collado emphasises the importance of looking into the future and investing in your business. By demonstrating a willingness to invest in the future, you can attract customers, retain employees, and create more value for your business.

Avail Small Business Loans

Small business loans can provide the necessary capital for business growth and addressing various financial needs. While there may be concerns about the potential financial repercussions of failure, it’s important to weigh the benefits and risks associated with obtaining a loan.

Small business loans can provide a significant influx of capital that allows you to invest in critical areas such as equipment purchases, expanding your team, or launching new marketing campaigns. This access to funds can accelerate your business growth and help you seize opportunities that would otherwise be challenging to pursue.

Keep Your Business and Personal Finances Separate

Maintaining separate business finances brings financial clarity to your business. By having dedicated business bank accounts, credit cards, and accounting systems, you can accurately track and manage your business’s financial health. This practice facilitates proper bookkeeping, financial reporting, and analysis, enabling informed decision-making.

Build Strong Business Credit

Maintaining good business credit is indeed crucial for accessing favorable financing options and facilitating business growth.Here are some additional tips to help you keep good credit:

• Pay all your bills, loans, and credit card balances on time
• Keep your debt levels manageable and avoid taking on more debt than you can comfortably repay
• Review your business credit reports from major credit bureaus for any errors or inaccuracies

Optimise Billing Strategies

Unpaid invoices are one of the major reasons that create losses in a business. If you have late-paying customers, you need to look at creative ways to get your payments done. Following are some strategies you can implement to streamline your cash flow system.

• Offer a discount for clients who pay their invoices before the due date. 
• If clients are struggling to pay the full amount upfront, consider offering instalment or payment plan options.
•  Implement automated payment systems, such as recurring billing or direct debit arrangements. This ensures that payments are automatically deducted from clients’ accounts on the due dates, minimising the chances of late payments.
• Consider working with an invoice factoring company that can purchase your unpaid invoices at a discounted rate, providing you with immediate cash flow.

 By implementing creative billing strategies, you can encourage timely payments and improve your business’s cash flow management.

Streamline Tax Payments

If you have trouble saving for your quarterly estimated tax payments, make it a monthly payment instead, said Michele Etzel, owner of Bayside Accounting Services. That way, you can treat tax payments like any other monthly operating expense.

By treating tax payments as a regular monthly expense, you can spread out the financial impact and make it easier to budget for your tax obligations. Utilize online tax software platforms to streamline your tax payments. These platforms often provide features to help you calculate your estimated taxes, track payments, and generate reports.

Balance Expenditures and ROI

Return on investment (ROI) is a ratio that measures the profitability of an investment by comparing the gain or loss to its cost. It helps assess the potential return of investments you have made. 

Measuring expenditures and return on investment (ROI) can give you a clear picture of which investments make sense and which may not be worth continuing.

“Focus on the ROI that comes with each of your expenditures”

Know where you are spending your hard-earned dollars and how that investment is paying off. If it isn’t paying off, cut back and spend a bit more on the initiatives that do work for you and your business.

Get a Corporate Credit Card For Your Business

There are many benefits to using a corporate credit card for your business. It helps keep the personal and business finances separate. It is also easier to track spending, monitor budgets and have documentation for tax purposes. Consider buying a corporate credit card like HDFC Bank Regalia First Credit Card, SBI Corporate Card or ICICI Bank Coral Corporate Credit Card for this purpose. 

These corporate credit cards are designed to cater to the needs of businesses in India, offering features such as expense management tools, employee spending controls, and rewards programs. The specific benefits, fees, and eligibility criteria may vary depending on the card issuer and the type of card. It’s essential to compare the options and choose a card that aligns with your business requirements and spending patterns.

Optimise Your Payroll Processes

Payroll is a recurring expense even for most small businesses and from tracking time to withholding and making tax payments, each aspect of running payroll requires the utmost attention to detail. Making use of a payroll processing software can help manage your finances better instead of using spreadsheets for the same task. 

An automated payroll system saves you time and effort and also makes complex compliance processes like TDS, PF, PT, and ESI error-free. You can also process employee insurance policies and reimbursements with an efficient payroll management system. Just by spending a few thousands each month, you can optimise this recurring task each month and ensure peace of mind. 

Quickbooks payroll, Keka HR and Zoho Payroll are examples of efficient cloud based payroll systems in India that automates payroll processing, compliance, and employee self-service.

Opt for a Financial Service/Tool

Did You Know?

Approximately 20% of new businesses fail during their first year of operations, almost half during their first five, and 70% at the end of the decade — with only 30% left standing. The leading cause of failure? Inadequate financial management.

This underlines the critical need for entrepreneurs to educate themselves about tools and software that enhance financial operations strategy. 

We will now explore some financial tools that every small business owner can use to manage money and take control of your finances. 

Quickbooks: QuickBooks allows you to keep track of financial functions like income and expenses, employee expenses and inventory in real-time and fulfil tax obligations hassle-free. 

Freshbooks: This is the best invoice and accounting software for small businesses. FreshBooks automates daily accounting activities namely invoice creation, payment acceptance, expenses tracking, billable time tracking, and financial reporting

Wave: This is a free financial accounting tool to take care of accounting, invoicing and receipt scanning. 

Zoho Books: Zoho Books is yet another affordable option for small business owners and entrepreneurs. It offers accounting, invoicing, and inventory management tools at a pocket-friendly price. It also integrates various other Zoho apps to cover financial process improvement. 

Also Read: 10 Important Financial Tools Every Small Business Must be Aware of 

Types of Small Business Financing

There are several types of financing available for small businesses. Let’s discuss each of these options to manage your small business’s finances in a healthy way.

Bank Loans

Traditional bank loans are a common source of financing for small businesses. These loans can be either short-term or long-term, secured or unsecured. Banks typically require a solid business plan, good credit scores, and collateral to approve a loan.

Crowdfunding

Crowdfunding platforms allow businesses to raise funds from a large number of people, typically via the internet. There are different types of crowdfunding, such as reward-based, equity-based, and debt-based crowdfunding. This can be a good option for startups or businesses with a unique product or service.

Small Business Grants

Grants are funds provided by government agencies, corporations, or foundations to support small businesses. Unlike loans, grants do not need to be repaid. However, they often have strict eligibility criteria and require a competitive application process.

Business Credit Card

Business credit cards can provide a flexible source of short-term financing for small businesses. They can be used for everyday expenses, such as office supplies or travel costs. However, interest rates can be high, so it’s important to pay off balances promptly.

Venture Capital

Venture capital is financing provided by investors to startups and small businesses with high growth potential in exchange for equity ownership. Venture capitalists typically invest large sums of money and often provide strategic advice and mentorship to the companies they invest in.

Short-Term Business Loans

Short-term business loans are designed to provide quick access to capital for short-term needs, such as managing cash flow gaps or taking advantage of a business opportunity. These loans typically have shorter repayment terms (less than a year) and can be easier to qualify for than traditional bank loans.

Manage Small Business Finances to Build Your Business

Managing finances is a critical aspect of running a successful small business. By implementing the strategies and tools discussed in this article, small business owners can take control of their financial health and position their businesses for long-term success.

To recap,

1. Conduct regular financial analysis to assess profitability, liquidity, and solvency.
2. Create a comprehensive financial plan that aligns with the business’s goals and objectives.
3. Pay yourself a fair salary 
4. Invest in growth opportunities to expand and improve the business.
5. Utilise small business loans and corporate credit cards strategically to support financial needs.
6. Keep business and personal finances separate to maintain clarity 
7. Build strong business credit to access favourable financing options.
8. Optimise billing strategies to encourage timely payments and improve cash flow.
9. Streamline tax payments by treating them as regular monthly expenses.
10. Balance expenditures and ROI to make informed investment decisions.
11. Leverage financial tools and services to automate and simplify financial management tasks.

By prioritising financial management and adopting these best tips for managing business finances, you can navigate the challenges of entrepreneurship and keep your small business up for long-term financial success. 

Remember, seeking professional guidance from accountants, financial advisors, and utilising the right tools can make a significant difference to ensure your business remains successful in the long run.

Frequently Asked Questions on How to Manage Finances in a Small Business