Beginner’s Guide to Managing Finances for a Small Business
When you start a small business, you go into it knowing there will be a lot of work that goes on behind the scenes. Managing the finances for a small business may not be a task that you enjoy the most, but it’s important for your business’s growth and success.
Since you may be a beginner at small business finance management, we’re highlighting the key actions that should be taken right from the start, whether you’re tackling this on your own or outsourcing to a financial partner.
Separate Your Business & Personal Finances
A crucial step in small business money management, especially for businesses just getting off the ground, is keeping the business’s finances separate from your personal finances. You may think that this is as simple as keeping receipts organized but there is more that you can do to create a more distinct division.
Your first step is to apply for an Employer ID Number (EIN). Not only will this serve as your tax identification during tax season, but it can also be used as a business ID when you open a bank account.
At a minimum, you should open a small business checking account and apply for a credit card. Not only do these accounts make your business look more professional, they also:
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- Minimize bookkeeping areas
- Isolate business expenses, which can be tax-deductible
- Shield you from personal liability for outstanding debt
- Help you build a credit history for your business.
- Make records easy to find in case of an audit
Another benefit of keeping your business and personal finances separate is everything will be organized in the event of an audit. The IRS allows deductions for business expenses. But if you don’t have proper documentation of these expenses, you might miss out on them if the IRS does an audit on your return.
Create a Budget
Having a budget is essential for any business since it will influence every decision you make. Create a detailed budget that accounts for all your business expenses and income. A proper budget can help you see what money is coming into and out of your business, helping you avoid debt.
Budgets help keep your business on track. You can also use past budgets to help you create growth plans for your business and find areas where you’re underperforming.
Manage Your Cash Flow
Creating a budget helps you manage your cash flow, which is the amount of money that moves into and out of your business. You can calculate your cash flow by subtracting your total cash outflow from the total cash inflow.
Having your cash flow information is helpful for investors since it can indicate your company’s financial health when combined with your other financial data. If they can see more profits than debt, it’ll be easier for them to invest in your business.
Create an Emergency Fund
Most people have a personal emergency fund in case of emergencies (if you don’t then check out our blog with tips to help you build one). But especially after COVID-19, having one for your business has become crucial.
To create an emergency fund, you can open a business checking or savings account. Having three to six month’s worth of expenses set aside can help your business get through financially tough times. While it seems like a lot of money to have on hand, by saving a little each month you’ll be able to reach your goal and have a security net.
Know Your Business Credit Scores
Everyone has a personal credit history that is used to calculate a credit score. This score is used by lenders to evaluate your creditworthiness. Small businesses also have a business credit score that is built upon their history of carrying and repaying debt responsibly.
Knowing your business credit score is another important step in managing finances for a small business. A poor credit score will limit your opportunities to obtain financing, purchase insurance, find real estate, and carry debt with vendors. Meanwhile, a high credit score will make these business transactions much easier.
If a low business credit score is holding you back, you might want to put spending plans on hold until you can improve your score. Consistently paying your bills on time and in full over several months can help raise your credit score to an acceptable level.
Understand Important Small Business Financial Documents
Not everyone who runs a small business has a head for finance and bookkeeping. Many choose to outsource these tasks to accounting professionals. But, as the business owner, it’s still important that you work with your small business financial advisor and accounting partners to ensure that you have a clear picture of your business’s key financial statements. Managing finances for a small business includes a periodic review and understanding of the following:
Balance Sheet — This is a snapshot of your business’s assets, liabilities, and equity, which are used to calculate your business’s net worth. In a “balanced” situation, your total assets would equal liabilities plus equity.
Income Statement — This is a breakdown of business revenue and expenses over the course of the year, which determines if your business had profits or losses for the year. This is often called a P&L (profit and loss) statement.
Cash Flow Statement — This tracks the inflow of revenue and outflow of expenses, showing you the amount of cash your business has on hand during a specific period (each month or each quarter).
Revenue Forecast — When you’re making decisions about the future of your business (like upgrading equipment or hiring employees), understanding your revenue forecast gives you a good idea of what you can afford. Your revenue forecast is an educated prediction, using past performance as a guide, of the revenue that you will earn in the future.
Statement of Owner’s Equity — These reports indicate the amount of money kept or reinvested into the business. This information shows an owner’s financial commitment and how much equity they have in their business.
Budget —As we mentioned above, every business should establish an annual budget to help them manage their business expenses and business growth. These reports are used with the cash flow and income statements to help project a business’s financial needs.
Business Plan — One of the most important documents a business should have is a business plan. This is a roadmap for your business and can help show lenders and investors your plan for growth.
Fine-Tune Your Billing Strategy
Another key component of small business money management is implementing a billing strategy that ensures you have cash coming into your business in a timely manner.
Here are a few ways you can ensure prompt payment from your customers and maintain a healthy cash flow:
Never delay invoicing. Whatever payment terms you’ve set in place, nothing will happen until the invoice is out the door.
Offer discounts for early payment. Many small businesses use invoicing strategies such as 2/10, Net 30. This provides your customers a 2% discount if they pay within 10 days, but requires full payment within 30 days.
Consider shorter payment terms. If you require full payment in 15 days, you may have customers who pay late, but in most cases, you will receive full payment sooner than the typical 30-day window.
Digital payments are the quickest way for customers to pay. Adding a digitized invoicing and payment process allows customers to pay with minimal effort.
Working with Diamond
Whether you’re opening your first small business banking account or applying for small business financing, our Business Resources page can help you with the products and services you need to manage your small business finances.
Diamond’s business experts in our Business Services Division can answer any questions you have and help you create a plan for your business.