Only half of US small businesses survive the first five years. Too many of them fail due to financial mismanagement. Entrepreneurs are often passionate about what they do. However, when they lack the understanding of all the financial elements of running a business, it can be detrimental.
In light of National Financial Literacy Month, here are three of the fundamentals of financial literacy for entrepreneurs:
1. Making and spending money
Otherwise referred to as a profit and loss statement, an income statement shows a business’ revenues, costs and expenses over a period of time. Put simply, it shows how much money is coming in and going out of a business. Calculating these elements, the income statement illustrates, throughout the year, the income a company makes or loses.
It tells you if you are making more than you are spending or vice versa. When comparing statements over time, it’s possible to see the operating performance of a business. Subsequently you can plan ahead in areas like goals, sales, inventory and overhead.
2. Ebbs and flows
Cash flow is the lifeblood of any business, and the cash flow statement shows changes to the cash coming into and going out of your business over a period of time. Only recording cash (not all income), it shows whether you can cover short term expenses like bills and payroll.
Being short of cash when it comes time to pay an employee or vendor isn’t something that any business owner wants to face, and using this document is key to preventing shortfalls.
3. Checks and balances
Like a scorecard for how the business is doing, a balance sheet is a snapshot of what a company owns and owes at a moment in time, rather than a forecast. It enables an entrepreneur to see how their company is paying for what it owns, either by borrowing money (debt) or taking money from investors (equity).
Comparing a balance sheet with those of previous periods will help show how the company has grown the assets of the business.
Understanding these fundamentals is important for a small business owner. Luckily these days, there are tools and resources to help fill in the blanks for them.
Xero enables small business owners to compile all of these reports. Furthermore the single ledger gives users the ability to easily share and review the documents with their accountant. Leveraging this relationship with their trusted advisor and using their accounting platform, small business owners can understand their organization’s financial health to not only survive the first year but thrive.