Small business owners often need to wear many hats. That’s why it’s crucial to be well-versed in a variety of areas, like product development, operations, marketing, and especially finance. Understanding even basic financial concepts can help you make the right money decisions for your company and strategically grow your business over time.
In the spirit of Financial Literacy Month, we’d like to cover some basics and give you tips for how to make yourself more financially savvy.
What is financial literacy?
Financial literacy refers to how well you grasp concepts, tools, and techniques related to money. This knowledge is necessary to make crucial business decisions at every stage. Think creating budgets, saving for a big project, making business investments, and even hiring.
To maintain and evolve your business, you’ll need to be comfortable managing and talking money, including knowing when to use and apply for business loans, lines of credit, and business credit cards. Your level of financial literacy is the foundation of your relationship with money—and can be a major determining factor in whether you reach your financial and business goals.
Why is financial literacy important for small businesses?
Besides setting the stage for you to meet your short- and long-term goals, your financial knowledge helps you handle and advise on day-to-day tasks and decisions. Effective leaders are well-rounded and can guide their teams on everything from budgeting and fundraising to product development, pricing, and accounting.
Without the proper foundational knowledge, you wouldn’t be able to diagnose specific issues with your cash flow or profit margins. However, by establishing a basic understanding—and continuing to learn about these financial concepts—you’ll be able to identify issues and offer swift, strategic solutions.
Financial literacy basics
Having a great product or service is not enough for a business to succeed. While making sense of everything numbers-related might seem overwhelming, decision-makers can focus on the following key concepts to expand their financial literacy.
Understanding financial statements
Financial statements give you a detailed picture of your company’s financial well-being. If you understand what different types of statements mean, you can use that information to make the right money decisions for your business.
Here are three statements that every business owner should be familiar with:
A balance sheet statement lists your company’s assets (what the company owns), liabilities (debts and obligations to others), and owner equity (the difference between assets and liabilities, referring to the true value of a business).
The balance sheet equation is Assets = Liabilities + Equity, meaning that your company’s assets must equal the sum of its liabilities and equity. Ideally, a business should have more assets on its balance sheet than liabilities, indicating a positive net worth.
A cash flow statement demonstrates the inflows and outflows of cash and cash equivalents. This statement provides information about how your business generates and uses cash, including operating, investing, and financing activities.
An income statement shows your company’s revenues, expenses, and net income (or net loss), providing information about your business’ financial performance and profitability.
Managing cash flow
Cash flow management helps identify how much money your business needs to pay expenses, debts, and yourself. Making educated decisions can help organizations avoid cash shortages, maintain a healthy financial position, have the necessary liquid assets to cover expenses, and take advantage of growth opportunities. Some business checking accounts let you separate your budgets into sub-accounts to make sure you have enough cash on hand for payroll, tax payments, etc.
To avoid cash flow shortages and make timely payments, you can also lean on online bill pay platforms to pay vendors on time and receive payments.
Filing taxes
There are several types of small business taxes you should be familiar with as an owner. Whether it’s income tax on net profits, employment tax, federal tax, or multi-state tax, all of them must be managed flawlessly to avoid red flags and audits. Although this may fall into both bookkeeping and accounting expertise, it’s easy to get them confused. While accountants and bookkeepers share a common goal of managing a company’s financial records, they do so at different stages of the financial cycle.
Accounting vs. bookkeeping
Bookkeeping is the foundation of accounting. It’s the process of recording and organizing daily financial transactions, helping track all the details, and creating financial statements. Accounting involves analyzing and interpreting the information provided by bookkeeping. It looks at the “big picture” to determine the financial health of a company, identify trends, and make performance improvement recommendations.
While knowing about accounting and bookkeeping can help you handle taxes with confidence, it’s not uncommon for business owners to outsource these responsibilities to professionals who specialize in these roles—which can help your small business stay compliant.
Making financial projections
Revenue forecasting is the process of estimating future sales revenue for a business. It helps identify the why, where, when, and how of your sales activities. Making projections allows you to make informed decisions about budgeting, investments, sales and marketing strategy, and resource allocation while maintaining financial stability and maximizing profit.
How to improve your financial literacy
For small business owners, it may seem overwhelming to fully grasp and take on the financial responsibilities of the organization. While you can outsource some roles to professionals, it’s still important to maintain financial literacy basics. We’ve outlined some simple steps that can help you become more a financially literate leader for your team.
1. Read and learn
Books, podcasts, and workshops are great tools to help understand the basics of financial planning, terminology, and analysis.
2. Keep up with new technology
Virtually everything can be learned online thanks to the digital tools dedicated to financial literacy. Technology also offers ease and flexibility to continue learning about finances and stay up to date with changes.
3. Build an understanding of credit
Borrowing money is a common strategy for small businesses to grow and expand. Whether considering a business loan or business line of credit, decision-makers must understand how credit history and credit scores work and can impact the loan limit, repayment time, and interest rate.
4. Use debt strategically
Although debt has a bad reputation, it can be used to a business’ advantage. For example, taking out a loan can help a business grow and can create additional sources of income to reduce debt.
5. Outsource when necessary
While business leaders wear many hats, it’s important to understand what is and isn’t your specialty or expertise. If managing finances is complicated or takes up too much time, it’s best to hire an internal accountant and/or bookkeeper, or outsource those responsibilities to an expert.
Financial literacy helps small business owners open their companies up to new possibilities by making sound financial decisions that can increase revenue. While becoming financially literate may seem like an overwhelming task, there are a plethora of resources and support available to help you grasp the financial basics to set your company up for success.
