As a business owner, no matter what kind of business you own and operate, you’re in the business of financial literacy. It’s important foundational knowledge for making key financial decisions that can determine the future and health of your company.
In this article, we’ll learn about financial statements, budgeting, and business credit to help you get a better understanding of the financial literacy components that determine your company’s health.
This may sound like financial literacy 101 – and that’s intentional! Getting the basics right gives us a solid foundation on which to grow.
If you want to know the ins and outs of your business, understanding financial statements is step number one. The three key financial statements include the balance sheet, income statement, and cash flow statement.
A balance sheet shows you what resources your business has available and how they were financed. Common terms on a balance sheet include assets, liabilities, and owner’s equity.
- Assets are what your company owns.
- Liabilities are what your company owes. This may include payroll, debt payments, rent, utilities, and taxes.
- Owners Equity is the net worth of your company. It’s what is left after you’ve subtracted your liabilities from your assets.
Banks and potential investors will use the data from your balance sheet to determine if your company is safe to invest in. The balance sheet tells banks if your company can meet its current debt obligations, has enough assets to pay off debts in case of liquidation, and if your company is at a current risk of over borrowing.
A few other balance sheet red flags that may make a bank hesitant to lend to you are having more liabilities than assets. This can make it harder to secure capital on favorable terms, or at all. Using the balance sheet as a tool to identify where your company is at risk will help you make informed decisions to make your company more appealing to lenders and investors.
An income statement summarizes your company’s financial transactions and how much you earned and spent. Common terms on an income statement include total revenue, COGS, gross profit, operating expense, and operating income.
- Total revenue is all the money that comes into your business
- The cost of goods serviced (COGS) is the price you pay to create products
- Gross profit is your total revenue subtracted by COGS
- Operating expenses are indirect costs associated with running your business
- Operating income is your revenue after all operating expenses are deducted
- Your net income is the cost of interest and tax from your operating income. This is your “bottom line.”
The data from an income statement allows banks to determine if the products or services your company sells are competitive in your industry’s landscape. It also informs them if the cost of selling and creating these products is sustainable in both the short and long term.
Banks often won’t look at just the income statement but will use it alongside a balance sheet to determine if you can pay off a loan. The more profitable your business is, the more likely it is to pay off the loan, and the more favorable terms you can negotiate.
Cash Flow Statement
A cash flow statement shows the cash that’s going in and out of your company. It demonstrates your ability to operate in both the short and long term. A cash flow statement is broken down into three sections.
- Operating Activities: Cash flow that’s generated after your company has delivered its regular goods or services
- Investing Activities: Cash flow from purchasing or selling assets
- Financing Activities: Cash flow from both debt and equity financing
If your cash flow statement indicates that your company is not bringing in enough cash to cover operating expenses and debt, a bank or investor may be hesitant to provide capital due to the unsustainability of your company.
Banks and investors will almost always want all three of these financial statements to evaluate if your company is capable of paying off a loan. Understanding these statements will allow you to assess the health of your company at a moment’s notice, and determine where you need to make adjustments to secure favorable financing.
A realistic budget allows your company to grow sustainably, mitigate financial risk, and create financing opportunities.
Creating a business budget can be broken down into a few steps:
Estimate Your Costs
The costs that your business incurs can be broken down into four broad categories.
- Fixed Costs (rent, salaries, insurance)
- Variable Costs (cost of goods sold, contract labor)
- One Time Costs (tenant improvements, new equipment)
- Unexpected Costs (equipment breaking down, damaged inventory)
Err on the side of caution and avoid underestimating costs when developing a budget.
Investors will want to see your budgeted spend versus your actual spend to see how your company handles its finances before providing capital.
Rely on your historical revenue to make more accurate predictions. You don’t want to overestimate and think the company has more money coming in than it actually does. This can lead to unhealthy financial decisions.
Your revenue predictions will indicate to investors if your company is growing financially or if adjustments need to be made.
Calculate Gross Profit Margin
Calculating your gross profit margin will inform you if you’re operating at a loss or profit. If you’re at a loss, you can look for expenses to cut to make the business more sustainable. If you’re operating at a profit, you’ll have funds left over to grow your business, hire talented staff, invest in equipment or inventory, or to set aside for emergencies.
Your gross profit margin will tell investors how efficient your production process is and if you can profit from selling your products or services.
Identify Slow and Busy Periods
Does your business have a slow season? Make sure your business has enough capital to get through weak sales cycles and is prepared to scale up when things get busy.
Investors will want to see that you’re doing due diligence when budgeting to ensure you know how to plan for your company’s future – both the highs and the lows.
Constantly monitor your budget to see where your company stands and what decisions need to be made to ensure financial sustainability. A company that’s attractive to lenders is one that knows how to adapt. You can show evidence of this in the way you budget and how you spend.
Business credit is a metric that proves your company’s ability to handle its finances and how trustworthy it is in repaying loans.
Business credit is calculated by one of the three main business credit bureaus which acquire information from business credit cards, banks, vendors, and other accounts payable data. Your payment history, debt, company size, industry risk, and how long you’ve been building business credit are all factored into your score.
A good credit score often means you can be eligible for larger lines of credit or bigger loans. Access to more capital can be crucial when you need a lifeline for your business or you want to strike at an opportunity to grow.
Have More Questions?
At Crown Bank, we take pride in helping Minnesota businesses grow. If you have more questions about the financial health of your business or would like to know how we can help your company grow, contact us today.