Big companies can easily employ accountants and get accounting software to help with their businesses but since many small business owners cannot afford that, it’s best to know how to manage finances for your small business. In this article, you’ll get tips on managing your small business finances.
Being an expert in a product or having the product or service that solves a problem can be a good reason to start a business. An entrepreneur can even succeed in that business if they focus on making a great product or delivering great service. Still, the fundamental goal of every entrepreneur is to make profit and prioritizing financial management is as important as the quality of your product or service. Always put financial targets that are feasible in place and follow up regularly to make sure you’re on track. This is one of the key ways you keep your business from failing.
Importance Of Financial Management
Businesses that prioritize financial management always:
- Have clear knowledge of when they are making profit or loss and so they can make decisions to improve profit and curb loss.
- Know when to adjust their prices to increase their profit.
- Maintain positive cash flow because they are aware of and regulate their income and outflow.
- Have great financial records that enables them to easily get loans from banks and funding from investors.
- Conduct sound financial analysis for better business forecasting and projections.
Profitability, efficiency and solvency are three important metrics you can use when managing your business’s finances.
Businesses should regularly create a profit and loss statement (income statement). This helps the business know the total profit or loss it has monthly, quarterly or yearly. The data from the income statement can be used to calculate your net profit margin, gross profit margin, and operating profit margin.
You can use these formulas to calculate those margins.
- Net Profit Margin:
This is how much a business makes after it is deducted from the revenue.
Net profit margin = net profit / sales x 100
- Gross Profit Margin:
When a business makes revenue from sales of their product, the money left over after cost of goods sold is deducted is the gross profit.
Gross profit margin = total sales – cost of sales / total sales x 100
- Operating Profit Margin:
Operating profit margin = operating income / revenue
Efficiency has to do with how well your business uses the assets and capital it has to generate revenue. There are a couple of metrics that can be used to gauge efficiency: Return on assets, working capital ratio and working capital turnover. You can get the information for these metrics from your balance sheet and income statement.
- Return on assets:
In simple terms, return on assets (ROA) means how much profit the assets of your business is generating. Your business is more efficient if your return on asset is higher than that of the previous month, quarter or year. ROA is what you get when you divide net income by your total assets.
You can calculate it using: Return on Assets = Net Income/Total Assets x 100
- Working Capital Ratio:
Working capital ratio is the ratio of a business’s assets to its liabilities. This metric is used to assess the financial health of a business. Working capital ratio is gotten when you divide your business’s current assets by the current liabilities.
You can calculate it using: Working capital ratio = Current assets/Current liabilities
Your business is efficient when your working capital ratio is high because a high working capital ratio indicates that your assets are well ahead of your liabilities. The opposite is true when the value of your working capital ratio is low.
- Working Capital Turnover:
Working capital turnover measures the effectiveness of a business at using every Naira of its working capital to get more sales.
The higher the working capital turnover the better. It shows that the business is able to generate a larger amount of sales.
You can calculate it using: Working capital turnover: Net annual sales/Average working capital
Solvency is the ability of a business to pay their long term financial debts. To measure solvency, or your business’s ability to pay its long-term debts, use the cash flow statement. It measures the amount of income and outflow of money in your business.
Calculating operating cash flow will indicate how well the company can cover its current liabilities.
You can calculate it using:
Operating cash flow ratio = net income + non-cash expenses + changes in working capital / current liabilities
Tips For Managing Your Finances
1. Have A Budget For Your Business:
Having a business budget can help your business in the following ways:
- It helps your business to be more efficient.
- You get to see if you have leftover funds you can reinvest.
- You’ll be able to predict slow months and know how to use your funds wisely.
- With a budget you will be able to know the steps to take to become profitable.
These are the component of a business budget:
- Your estimated revenue. This is the amount you expect to make from the sale of goods or services
- Your fixed costs
- Variable costs
- One-off costs
- Cash flow
2. Take Bookkeeping Seriously
This is an obvious practice, but a very important one so you should do your best to set aside time each day or month to review and monitor your books, even if you’re working with a bookkeeper. It will allow you to become more familiar with the finances of your business, but also provide you with a window into potential financial problems.
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My name is Emmanuel Ejiga. Content lead of OG Capital
I am a writer. Technical writer, song writer, and sometimes fictional writer.