Understanding the Costs of Daily Operations
In recognition of Small Business Month, Whitaker-Myers Wealth Managers is partnering with our CPA and fellow small business owner, Kage Rush, to discuss the thought process and steps needed to open and continue to operate a successful small business or side hustle. Our first article covered things to consider when starting a small business, and our second article covered the different types of entities to consider when creating your small business. This article will discuss how to understand your business from a financial perspective better and how this understanding can help you in the day-to-day operations of your business.
Reviewing Your Finances: The Reactive Approach
Once the small business is up and running, entrepreneurs can become swamped with day-to-day operations and lose sight of their business’s financial side/health. Most often, entrepreneurs only look at the financials of their business for the following reasons:
Filing their personal taxes during tax time
Wanting to purchase a significant asset or employee hire
Economic downturn has caused a cash flow issue in the business
For the above reasons, entrepreneurs usually look at their financials from a reactive approach. This means the entrepreneur is looking at their financials because it’s tax season and there is a large tax due on their return, equipment breaks down in the business and needs to be replaced, or a sudden market change has occurred and caused an unplanned cash flow shortage in the business. The issues with using a reactive approach to the financial side of the business can be the following:
We can’t go back in time to fix errors or spend money
This approach can stunt the growth of your business
You could lose opportunities to grow your business
You could face unnecessary economic hardship
Reviewing Your Finances: The Proactive Approach
Successful entrepreneurs and business owners mostly approach the financial side of their businesses proactively. This means the entrepreneur is looking at their financials to plan for events to occur in the future, anticipate tax bills associated with their business profits, and try to factor current and future market conditions into their day-to-day business operations and long-term planning. The first step to taking a proactive approach to your financials is clearly understanding how your revenue/expenses are generated. Here are some questions to ask yourself about your revenue and expenses:
How long does it take to get paid for services provided?
For example, if it takes 30 days to receive payment for services provided to a client, you can expect services provided in February to be paid in March.
When are my most significant expenses due, and what is the frequency of those expenses?
For most owners, this could be payroll to employees paid monthly, bi-weekly, or twice a month.
What causes a lag between services provided and payment received for services?
How do you request payment for services provided?
Do you request payment by just cash or check? Or do you provide ACH and credit card options?
Do you bill for your services in advance, as the services are performed, or after the service has been completed?
Completing step one is critical to understanding and growing your business because it can guide a small business owner to make decisions to improve their business model to collect payment faster from clients, offer additional methods of payment to improve cash flow, and adequately plan for expenses so you aren’t forced into a situation where cash flow is insufficient to cover the costs. Once you understand your revenue/expenses, you can create financial statements to help analyze your performance and strategize how to grow your business.
Tools to use
Two common financial statements used in a small business are a balance sheet and an income statement. A balance sheet looks at your assets (cash, accounts receivable, inventory, etc.) and liabilities and equity (accounts payable, loans, mortgages, net income, etc.) at a point in time (ex., May 31, 2023). An income statement reviews your revenue and expenses over a period of time (ex., May 1 to May 31, 2023). Both statements are suitable for evaluating your past performance and can be compared to a prior year, but they do not compare you to your current expectations. A third financial statement that can be used in your small business is a budget vs. actual analysis.
An example of a budget vs. actual analysis statement would take your actual performance from May 1 to May 31, 2023, and compare that to what you budgeted for that same period. This can be useful for owners to know if the business is meeting their expectations set at the start of the fiscal year and if future expectations need to be adjusted based on actual performance. The keys to having a reasonable budget are the following:
Your budget is reasonable based on market expectations, knowledge of the business, and past experience
Your goals for the business are aligned with the expectations for the budget
There are clear indicators for your budget that can guide success or failure
Your budget is not static and can be adjusted as factors change, whether from external or internal sources
Your budget has input from all sources of your company
You have created a plan to implement your budget for your staff
Small Businesses Impact
I wanted to end this article with an interesting fact. According to the US Chamber of Commerce, there are 33.2 million small businesses in America (500 employees or fewer), which accounts for 99.9% of all U.S. businesses. Hopefully, this statistic opens your eyes to how much small businesses impact our economy and inspire you to join in with your own creative business to be successful.
My hope with this three-part series is that these articles helped give you ways to understand your business better and valuable insight into starting, growing, and prospering with your own business one day.
If you are interested in starting your own small business and have accounting questions or need accounting services, please contact your financial advisor or visit our tax website to schedule an appointment.
Comments