One of the most important concepts that entrepreneurs must understand and master is how to manage the finances of their business. Many people dream of launching a company and making their own money instead of helping someone else get rich. This dream can only become a reality if you know how to manage money. Here are my top 10 keys to effectively managing your business finances.
Understand Your Numbers
Many entrepreneurs start a business thinking, “I’m going to sell this, charge that, and take home this much.” It’s not that easy.
When you start a business, you need to understand all the numbers involved. Here are the basics, in a nutshell:
- Sales/Revenue: The money you get from selling your product or service.
- Costs: How much it costs you to make that sale.
- Expenses: Operational costs like raw materials, labor, rent, utilities, insurance, and marketing.
- Net Income: What’s left of your revenue after subtracting costs and expenses.
Businesses in different industries often have different relationships between costs, expenses, and revenue, for example:{
Services
- Costs: 20% to 30%
- Operating Expenses: 50% to 60%
- Net Income: 10% to 20%
Retail
- Costs: 60% to 70%
- Operating Expenses: 20% to 30%
- Net Income: 2% to 10%
Restaurants
- Costs: 30% to 40%
- Operating Expenses: 20% to 30%
- Labor: 30% to 40%
- Net Income: 5% to 10%
Create a Budget
The second most important key to successful financial management of a business is the budget. A budget focuses on how much money the business earns and spends and sets goals for the upcoming year.
Each year, in the fall, I analyze my numbers to see how the business is doing and what it needs to succeed. I use the budget as a roadmap to set revenue and profit goals and determine how much I’ll need to spend to achieve them.
Analyze Your Profit Margins
Always, always, always analyze your profit margins and stay on top of your costs and expenses. Only then can you be creative with your numbers, for example, adjusting prices, reducing costs or expenses to improve your figures.
The profit margin is a financial ratio that measures how much profit your company generates for every dollar of revenue it generates. It is calculated by dividing net income by total revenue, then multiplying the result by 100 to get a percentage.
For example, a company with $1 million in revenue and $200,000 in net income has a profit margin of 20%. In simpler terms, the company makes a profit of $20 for every $100 of revenue it generates, or 20 cents for every dollar.
Did I say always?
Control Your Cash Flow
A common mistake many entrepreneurs make is equating selling their products or services with having money in the bank. It doesn’t work that way.
When you make a sale, you don’t get paid immediately. Companies typically have 30 days to make a payment. Although you’re generating that sale right now (and you want to celebrate with an all-inclusive cruise to Hawaii), you won’t see a dime for at least another month. That money isn’t in the bank yet and isn’t available as cash flow.
To succeed, a business needs money in the bank. That’s why companies always strive to pay suppliers as slowly as possible and collect money from customers as quickly as possible. Since everyone wants the same thing, maintaining positive cash flow can be challenging.
Separate Your Personal and Business Finances
This is another super important key to success. If neglected, it can quickly ruin your business.
When you have your own company, you may be tempted to blur the lines between your personal interests and your business interests. Don’t do it!
Your business allows you to live your dream of being an entrepreneur and having (or working for) the lifestyle you want, so don’t mess with the cash register. Assign yourself a small salary at first, and as your business grows, your salary will grow too.
Build Good Relationships with Your Suppliers
Your business depends not only on customers but also on the people who provide you with the products and services you need to make and sell your own products and services.
Business relationships based on a good relationship and trust are essential. Why? Because when you find yourself in a tough situation (e.g., payments or deadlines), your suppliers will be willing to work with you. If you treat them poorly, if you don’t develop good relationships, when you need help, and trust me, you will, they won’t be there.
So treat your suppliers well, even exceptionally well.
Stay on Top of Accounts Receivable
I know many professionals, lawyers, doctors, freelancers, who are diligent in selling and providing their services but forget to bill their clients. Their excuse? “I don’t have time to do the billing.” You don’t have time to bill your clients? How do you expect to keep your business?
Billing, or issuing invoices, is the first thing you should do, sometimes even before delivering the product or service you just sold. The longer you wait to send the invoice, the longer you’ll have to wait to get paid.
Besides billing quickly, you must follow up to ensure you collect the money as soon as possible. As Shakira says: “Women no longer cry. They bill.” But the key is not just to bill your clients. You must collect the payments.
It’s logical, right? Yet you’d be surprised at how many entrepreneurs don’t get it. Let me give you an example of a conversation I’ve had with several entrepreneurs: Proud Entrepreneur: “I have $100,000 on the street!” Carlos: “Great! Is it in the bank?” Entrepreneur: “Well, I haven’t sent the invoice yet.” Carlos: “What do you mean you haven’t sent the invoice?” Entrepreneur: “I haven’t had time. Billing is a hassle.” Carlos: “Losing your business is an even bigger hassle.”
Friends, money doesn’t grow on trees, and payments don’t get made without invoices.
Plan for the Long Term
Effective financial management requires a long-term plan that includes a budget and strategies focused on achieving specific goals over several years.
This is very important because you can’t set goals, define a clear direction, and allocate resources toward those goals without planning ahead. Having a long-term plan helps you make smarter business decisions, improve your company’s performance, and achieve better results.
Create an Emergency Fund
When many clients decide to pay late one month or you face unforeseen interruptions in your business, an emergency fund provides you with the cash needed to keep operating.
An emergency fund saved my digital marketing agency on more than one occasion. Hurricane Maria in 2017 and the recent Covid-19 pandemic forced many businesses to file for bankruptcy and permanently close. My business survived because it had an emergency fund that provided enough cash flow to keep operating.
Work with Financial Professionals
If you want things done right, and trust me, you do, you need to have financial professionals by your side, sometimes to your right and also to your left. Accountants, financial advisors, insurance agents, tax advisors, and investment bankers, among other financial professionals, can help you develop a budget, monitor your margins, create monthly and quarterly financial statements, manage your cash flow, and make solid investments, among other things. Don’t wait until you need them to hire them.
Final Thoughts
Effective financial management is crucial to the success of your business. It’s what can show you the money, ensure you have a sustainable business model, and pay for that cruise to Hawaii.
Remember, entrepreneurs who build successful businesses help create wealth and employment and promote a prosperous society where we can all move forward.
