Financial Literacy

Most of the top causes of small business failure involve financial errors: insufficient initial funding, rampant cash flow problems, poor financial planning, inadequate market size and the like. Therefore, if you want to build a small business that will last, you need to have the advanced financial literacy to keep your company afloat.

Being capable of managing your personal wealth is one thing; having the financial expertise to build a strong and stable small business is quite another. Here is a beginner’s guide to small business financial literacy, so you can start gaining the knowledge and skills to make your entrepreneurial dreams come true.

What Financially Literate Small Business Owners Can Do

Financial literacy is arguably the most important skill for small business owners, as it is essential in managing some of the most important tasks of building and maintaining a business. Those tasks include:

Manage Cash Flow

Cash flow covers all of a business’s incoming and outgoing money. Managing cash flow matters because businesses always need enough liquid assets to cover their expenses; in other words, business leaders need to understand their top line vs. their bottom line, or they may not be able to afford the resources essential for operation. Cash flow problems are consistently among the leading causes of small business failure, so for this ability alone, it pays to be financially literate.

Handle Taxes

There are many different types of taxes that apply to small businesses. While small business owners could outsource tax preparation to a third-party, the ability to manage this financial task yourself could save you money and keep the rest of your finances in proper order.

Analyze Financial Statements

Perhaps the most valuable ability granted by financial literacy is understanding financial statements. Documents like those listed below contain exceedingly important information that savvy business owners can use to make better business decisions.

Basic Financial Documents for Small Businesses

If you invest in no other financial skills, you should at least familiarize yourself with basic financial documents, which will be essential for understanding, organizing and growing your small business. Every small business utilizes the following financial documents:

Profit and Loss Statements, also called income statements or statements of operations. This document shows how much revenue a business has accrued, how that revenue was chipped away through expenses and whether the business turned a profit over a specific period.

Cash Flow Statements. These statements offer a detailed look at the cash flowing in and out of an organization. Unlike a P&L, a cash flow statement focuses on liquid assets (primarily cash)  gained and lost over a specific period.

Balance Sheets. These documents detail a company’s assets, equity, liabilities and other elements that typically aren’t covered on P&L statements. Most often, balance sheets highlight what a company owns and what it owes, which can help business leaders make leveraging decisions.

Break-even Analyses. The break-even point is when cost and revenue are equal — which is not usually the goal for businesses. Still, a break-even analysis can help leaders determine how much money they can spend and how much revenue they will need before they can reach profitability.

Business Ratios. Ratios are essential tools in business finance because they make it easy to understand complex information. Some common ratios small business owners are likely to benefit from include:

• Net Profit Margin ratio: net profit after taxes / net sales
• Gross Profit Margin ratio: (revenue – cost of goods sold) / revenue
• Profit margin ratio: (revenue – expenses) / revenue
• Quick ratio: (cash + marketable securities + accounts receivable) / current liabilities OR (current assets – inventory) / current liabilities
• Return on investment ratio: (gain from investment – cost of investment) / cost of investment
• Current ratio: current assets / current liabilities
• Common size ratio: line item / total

It is tempting to assume that you will be able to learn the financial processes involved in small business ownership as you build your business, but the truth is that too much of your business success hinges on your ability to manage your finances effectively from the start. By putting time and effort into gaining greater financial literacy, you will reap the rewards of a small business that not only survives — it thrives.