Financial Literacy Basics for Prospective Small Business Owners

I came across this article in Prairie Business Magazine the other day. The author, Matt Varilek, does a great job of identifying some major pieces of information that nascent entrepreneurs should consider before they fully commit to starting a business.  Great insight. Take the time to think about these issues before you commit your time and money. I want to thank Matt, our guest blogger, and David for approving the reprint.

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startup business Scrabble tiles

Photo (CC) by Dennis Skley, on Flickr

What to Know Before You Take the Plunge

by Matt Varilek, SBA Region VIII Administrator

What should entrepreneurs be aware of before they decide to devote a considerable amount of time, effort and resources to a small business start-up?  Here are ten financial literacy ‘hot buttons’ for new entrepreneurs and prospective small business owners to consider:

Know Your Own (and Your Family’s) Tolerance for Financial Risk.  There are no assurances there will be either short or long-term financial stability, so everyone involved in the start-up should have the emotional and financial capacity for a high level of uncertainty.  Also, using personal savings, a 401(k) or other retirement plan monies is a serious decision that one must carefully consider if there’s a potential for loss of funds.

Learn How a Legal Business Structure Can Impact Your Future Tax Liability.  There are different tax advantages associated with formal corporate structures that accrue to both the company and the owners, and tax law changes nearly every year.  Discussing the available business structure options with a qualified accounting or legal professional can help determine the best course of action when forming the business.

Understand How Much Money it REALLY Takes to Start Your Business.  Unfortunately, most all start-up projections for revenue growth are too optimistic, expenses are underestimated, and anticipated breakeven timeframes are too short.  A good plan is to double the projected cost to get to breakeven, and triple the timeframes.  Being prepared for a possible worst case scenario is good financial insurance against running out of time and money on the cusp of success.

Understand What Start-up Expenses are Crucial versus Questionable.  Focusing on expenses that directly relate to revenue generation is one of the keys to financially managing a start-up.   Every start-up expense should answer the question: “How does this contribute to the bottom line and get me closer to breakeven?”

Learn When it Makes Sense to Use Business Credit.  Business credit should be considered only when the money received can be used for either of two purposes: increase revenues, or reduce the costs of doing business.  Business credit should not be used to maintain a desired lifestyle, provide for the owner’s salary, or for anything that cannot be directly tied to bottom-line results.  In some cases, scaling back a start-up is a wiser choice than incurring business debt.

Understand the Relationship Between Your Credit History and Business Lending.  Lenders are literally ‘banking’ on the owner’s prospects for success, and how an owner has managed their own personal finances to that point is an important indicator.  Even a compelling business plan may not overcome an owner’s poor or marginal credit history.  After a year or two, availability of a business loan is more likely to be based on the company’s credit and operational histories.

Learn How to Record and Track Business Income and Expenses.  First, accountants can only work with what they see.  If it’s not recorded, it didn’t happen.  Second, accurate records enable a business owner to gauge the financial health of the business through the use of ratios and other financial measurements.  Having at least a basic computer-based financial system (i.e. like QuickBooks or equivalent) and keeping up with regular data input is a must.

Learn How to Read, Interpret and Use Business Financial Statements.  The Income Statement, Balance Sheet and Cash Flow Statement each tell a different part of the story about the company’s financial condition. Together, they can be used to find company weaknesses and strengths.  Ratios derived from various sections of the financial statements provide clues to where a business owner needs to implement corrective actions before a situation becomes serious.

Understand How Cash Flow Keeps a Business Alive.  A business can be profitable on paper, yet fail from a lack of cash flow.  Important aspects of cash flow include the timing of accounts payable and receivable, inventory turnover, fixed expense loads and other areas.  Without a solid foundational knowledge of such areas, a business owner is handicapped in terms of actually managing the company’s cash.

Understand the Financial Implications of a New Hire.  Two major questions should be answered before anyone is hired: “How will they enable the business to increase revenues, or How will they enable the business to be more efficient?” (i.e. more productive).  Quantifying these areas will help determine if a potential new hire is really worth what you will pay them in wages, benefits and training time.  Avoiding the temptation to hire too soon is one of a business owner’s major challenges.

 

As the economy continues to recover from the recent Recession, a business owner’s financial literacy is as crucial to the prospects of a business as it would be to any one of us in managing our personal financial affairs.

(Business financial literacy is part of the curriculum provided by one or more of SBA’s major Resource Partners…SCORE, Small Business Development Centers and Women’s Business Centers.  All can be found through the sba.gov website.)

Reprint approved by:

David D. Leavitt Jr.,

Regional Communications Director, Region VIII

U.S. Small Business Administration

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