Build a Strong Financial Foundation for Your Business
Learn the keys to building a strong financial engine to manage and grow your business.
The key to running a successful small business is a solid financial foundation.
At any stage of your business, whether you’re just starting or you’re a seasoned entrepreneur, there is a direct correlation between having a firm grasp on your financials and running a profitable business.
However, most entrepreneurs don’t go into business because they are passionate about financials. Managing the financials is often the least exciting thing about running your own business. As a result, many owners avoid digging into their numbers and instead focus on other areas of the business. This is a mistake. Even if your business is excelling in other areas, you must stay focused on managing your company’s cash flow to avoid jeopardizing everything you’ve worked towards.
To manage and grow a sustainable business you must develop a holistic view of the business, grounded by the financials.
In working with hundreds of entrepreneurs, we’ve found the first step in developing a strong financial foundation is getting a firm grasp on financial planning and the impact it has on your business. Analyzing your company’s finances will provide clarity on the health of your business as well as help guide your strategy toward accomplishing your company’s long-term vision.
We’ve pulled our resources together to create a guide that you can use to build a strong financial foundation for your business. In this article, we will talk about how to establish a foundation by tracking and reporting your financials, how to analyze your profit margin by looking at each product/service offering and how to use data to make decisions and grow your business. We’ll also share a few key takeaways including:
- How to establish your financial foundation in three easy steps
- A free tool to help you build out custom reports for your business
- A practical method to calculate profit per product or service
With these resources, you’ll be armed with the tools you need to understand how much money your business has at all times so that you can spot trends, avoid obstacles, identify opportunities, and grow a sustainable business.
Establishing Your Financial Foundation
The easiest way to get a hold of your finances is by looking at your financial statements. Financial statements offer a snapshot of how the business is running and whether it’s profitable, and, as an owner, analyzing your financial statements can help you with accuracy, accountability, and decision making later on.
There are 3 steps you can take to accurately track and report your financials. We suggest taking time to digest each step and build out the systems to track your finances. Then, in section 2, we’ll introduce a tool you can use to take a closer look at your businesses’ profitability.
1) Annual Budget & Expense Tracking
Every successful business needs a detailed and realistic budget. Your budget sets the framework for your business’ finances. It acts as a guide and provides essential information for operating within your means.
Budgets are only useful if you follow them. As the owner, we recommend you spend an hour each week reviewing your expenses to measure performance against expectations. Expense tracking helps you to identify how much you’re truly spending each month in various areas of the business. It gives you direct insight into where you might be over or underspending.
At first, you may need between 4-8 hours to build the systems to track and categorize your expenses. We recommend starting with the categories in our Cash Flow Tool (shown below).
2) Profits and Loss Statement
Your profit and loss statement, also known as an Income statement or simply a P&L, highlights the revenues and expenses of your business, and resulting profit or loss over a specific period (a month, a quarter, or a year). At a high level, your P&L tells you whether or not your business is profitable, and if your business model is sustainable.
Beyond telling you if your business is generating profit, your P&L can provide insight into your highest and lowest revenue streams and where your business is spending too much money. It can also aid in helping you answer some of those burning questions about your business including whether or not you have enough revenue to cover your expenses or if you can afford to pay yourself more.
Your P&L should be broken down into five main sections:
- Income: The total amount of money generated through your business’s products or services
- Costs of Goods Sold (COGS): The cost of the merchandise
- Expenses: Any costs of doing business, (i.e., office supplies, software, marketing, advertising, employee salaries, etc.)
- Other Income/Expenses: miscellaneous income or expenses not included above
- Net Income: The sum of Income – (COGS – Expenses – Other Expenses) + Other Income
3) Monthly Cash Flow Statement
While your P&L statement shows you the overall profitability of the business as it operates today (income minus expenses), it does not include activities such as debt repayment. Your cash flow statement goes in a little more detail to highlight what the remaining cash-on-hand for the given month is after the additional cash outlays not recorded in the P&L.
Your cash flow statement tracks how much money is coming into and going out of your business each month. A cash flow statement is utilized to help you operate the business better. It will show you when cash is low or high based on your expenses and seasonality. From there, you’ll know when you can invest in growth or when you should be wary of taking on new expenses.
Since things change daily, having an understanding of how much money is flowing in and out of your business is crucial in ensuring your business has enough money to keep running. Cash flow management is keeping track of this flow and analyzing any changes, which allows you to spot trends and identify opportunities to prepare for the future.
Your first step in building out your cash flow statements is to start with our Pro Forma. This tool allows you to plug in your revenue and expenses from previous months to project your cash flow into the future. Understanding how to track and project your cash flow will help you make informed decisions based on your past performance to help run a more profitable business.
While the cash flow statement is often considered the most important financial statement for a small business, these three documents are interrelated. Viewing them holistically can help you make smart financial, investment, and management decisions for your business.
Next, you need to consider profitability. Most business owners understand profitability fundamentally. If you have positive cash flow, meaning you take in more money than you spend, your business is profitable.
However, as an owner looking to grow your business, it’s important to look at what’s driving those numbers at a more detailed level. You need to analyze what makes up your profit margin by adding up the costs that go into delivering your product/service.
Profitability Per Widget
To do this analysis, you need to break down your company into what is called a “widget.” A widget represents the sum of the costs that it takes to deliver on your product or service. The goal is to identify the profit each time you deliver on that product or service.
Some companies may have multiple widgets. You will want to run this analysis on all of your products or services as, more often than not, it becomes obvious what is making you money and what is holding you back from making even more money.
To help you do this calculation, we have built another free tool for you to identify the true costs per widget. You can access it here.
By looking at the cost per widget, you’re in essence, pulling back the curtain on your business. You’ll know with certainty how each offering is profiting your business, and, you’ll have a better idea of some of the levers in your business you can play with to adjust the gap in your cash flow.
Understanding the impact each widget has on your company can help you to identify any bottlenecks in your business. And by taking that information you can begin to make small tweaks to start strategically growing your business.
Growing Your Business
Now that you understand how to establish your foundation by setting up reporting and analytics, and what makes up those reports based on the widgets in your company, now we are going to talk about how to put these into action.
It’s time to ask yourself, where do I see myself and my business in 5 years? At the end of this year? How much money do I want to make? How many people do I want to hire?
All these questions can and should be answered because now you have the financial tools in place to understand what would have to be done to get there. If you haven’t created your vision and goals, you can access our vision and goal planner here.
With all of this information in one place, you have all the information to see where you should be focusing to grow your business faster and more sustainably. When your business is first starting you might be in a position where you will say yes to anything to get the business off the ground. It is through that experimentation that you can find different revenue streams for your business. But as you move from one business stage to another (see what business stage you’re operating in), you might need to tighten your focus. This could mean trimming the fat or letting go of an offering that either doesn’t generate revenue or take up too much time to produce for the amount of revenue they generate.
Often, business owners forget to account for their time when looking at the true cost of a product or service. By running all of your offerings through the cost per unit calculator, you’ll be able to identify how much something costs you in time and production.
Regardless of whether you offer a product or service, using these tools will help you to uncover an area of your business that isn’t adding up. It will give you the data to understand and identify areas that are preventing you from seeing the growth your business is capable of.
You don’t need to be a financial expert to have a strong financial foundation for your business. Having a better understanding of your accounting can go a long way to better manage and monitor your business’s health. If numbers aren’t your thing, and you don’t know where to start, you don’t have to go at it alone. Schedule a free two-hour session to dig into your business and develop a plan.
Looking for resources on how to manage cash flow management during a crisis? Check out our free webinar on how to build out a financial tracking system.