Understanding small business finances: Where to even start?

We all know the importance of small businesses to economies around the world. In the US, small firms employ about half of all private sector employees. Yet, according to Bloomberg, eight out of 10 companies fail within 18 months of opening for business. Virgin founder, Sir Richard Branson goes so far as to say that, “It’s an endurance race that only a few survive.” He also lists three ways to stay in business longer:

  1. Select your employees wisely
  2. Find a mentor
  3. Choose your clients carefully

And at Sage, we believe there’s another way:

  1. Know and understand your numbers

Small business owners are often not accountants, and nor do they need to be. But they do need to get a handle on their business’s finances. Author Richard Weinberger says, “A lack of knowledge of basic finance is a common — and dangerous — mistake. Too many business owners don’t understand their own finances, and have no idea what products or services make the most profit.”

Why is it important that I know my financials? What do they mean to me?

Check out our e-book, Financial Reporting For Small Businesses Made Easy for deeper insights into this topic.

Are your financials simply the monetary value of your income and expenses, and your profits and losses?  Or do they mean more than that—is it also how you earn and spend your money, where and when you make or spend this money? Here we’ll look at why it’s important to know your financials as a small business owner.

Most small business owners associate their business’s financials with something that banks require to grant credit or to open an account. However, your financials mean much more than this. At a high level, your financials refer to important reports or statements that offer you great insights into the financial health of your business. It’s important to know what these are and where they come from so that you’re aware of how your business is doing at any given time.

A regular financial health check

The three most important financial statements are the balance sheet, income statement and cash flow statement. Not sure what each statement means or why it’s important to understand them? Neither did Sally, owner of Sally’s Necessities—a furniture and household items boutique, before she started growing her business into the successful operation it is today. We’ll use her as an example to explore what she learned:

The balance sheet

The balance sheet of a business essentially identifies its net worth. With this statement, Sally can identify whether the assets of the business exceeded its liabilities. This helps her get a snapshot of her company’s health by indicating how much her company owns (its assets), and how much it owes (its liabilities).

Income statement

A business’s performance or results is reflected in the income statement. When Sally needs to know if her business made a profit or a loss over a certain period, this is the report she looks at. This statement is generally divided into two parts: the operating and non-operating sections. In Sally’s Necessities’ case, the business creates, imports and sells furniture and household items, and so the operating items section would talk to the revenues and expenses involved with the production, importing and selling of these goods. The non-operating items section discloses revenue and expense information about activities that are not tied directly to the company’s regular operations. For example, if Sally’s Necessities sold a tool that helps make furniture, this information would be placed in the non-operating items section.

The cash flow statement

For small business owners, how you manage your cash is especially important because your startup capital may not be enough to run the day-to-day expenses of your business, and so you would need to forecast and plan for cash coming in and going out as accurately as possible. Knowing and understanding what her business’s income is and where it comes from allows Sally to determine what she has in the bank to spend. This helps ensure that she pays her suppliers and staff on time.

The three main financial statements mentioned here are what small business owners really need to wrap their heads around, however other reports can add tremendous value too, for example; a sales report. Remember that your financial reports should be customized to suit your business so that they can be analyzed optimally, especially the income statement. It’s important to have accurate and timely financial statements available to understand and run your business effectively. Without these financial statements, you’ll be blind to the financial health of your business, and long-term sustainability would become extremely difficult.