Owning a small business is a dream of many Americans. Being your own boss is attractive and can be financially rewarding. The truth is that it is not easy, and many businesses fail or do not meet the expectations of the owner(s) that were present at the beginning. Some may mishandle managing small business finances without even realizing it.

Managing Small Business Finances Effectively

Running a successful business is a process. The following tips will help small business owners maximize their chances of reaching that success.

Tip 1: Find a Business Worth Pursuing

Many people have ideas for a new business. Some are innovative and some imitate or improve upon existing businesses. Some take an already proven concept and just turn it on and hope it runs (franchise). 

Regardless, the idea must be sound and have a market. A market is a group of consumers who are willing to pay for the product or service in an amount that makes the effort worthwhile. This can be financial, and usually is, but other factors, such as freedom, time, family considerations, or faith in an idea, are also important.  

In general, a business worth pursuing is one of two types.

The first is creating a job for oneself. This is the essence of the sole proprietor. It doesn’t matter what the product or service is, the prospective owner has an idea or an opportunity that they can provide on their own, with no employees and often very little overhead. 

If they are willing to put in the time and can sell their product or service at a price that will satisfy their financial needs, then the question is whether the return is worth the effort put in. If it is, then it is a business worth pursuing. 

This type of business will often be seen in professional or consulting services, or it may be a situation where a person is working for a large company that is looking to cut costs and may be willing to use one of its employees as a contractor. It is also seen in the relatively new gig economy. 

The second is creating a business that eventually grows apart from the original owner into an entity of its own. The obvious example is Apple, which we all know was begun in a garage and is now one of the largest companies in the world. This was clearly a business worth pursuing but is much more complicated and requires a great deal of planning, expertise, capital, and patience. 

It may take years to produce results that make the effort worthwhile. The costs can be significant, especially at the beginning, and may require finding loans or investors (who will want a percentage of the ownership) to help cover those costs.

Either type can be viable. It is up to the entrepreneur to determine what their goals are and how much time and money they are willing to invest. But every person who wants to start a business needs to make a careful analysis of the opportunity to make sure it is worth pursuing.

Tip 2: Make a Profit

If the business is worth pursuing, it must make a profit to continue fulfilling its purpose. This is essential for several reasons:

  1. It makes the effort worthwhile.
  2. The business continues to operate so that it can provide a product or service that benefits others which they will pay for.

Profit is good because both sides benefit and society and the economy grow. It is also the scoreboard to evaluate whether the business is worth pursuing.  

Tip 3:  Have a Proper Set of Books

If a business is to succeed, it must make a profit. Many businesses have failed because the owner thought that they could just look at the balance in the checking account and if there was money there everything was okay. That may be true in some very simple cash-based businesses. 

Larger and more complex businesses need a proper set of books to see if a profit is being made so that the business can continue, is strong financially and so that can plan for its future.

A proper set of books has two components.

Bookkeeping. This is the process of making sure that the numbers are right. There are specific rules that have been developed to make sure that this is accomplished. It is often called the accounting cycle and generally includes the following steps done at least monthly:

  1. Identify all transactions.
  2. Record the transactions in a journal.
  3. Total the journal on a timely basis and record in a ledger.
  4. Review the balances in the ledger and make any necessary adjustments.
  5. Prepare financial statements (see “Accounting” below).
  6. Close the books for the period.
  7. Repeat the process for the next period.

This can be done manually or with the use of popular bookkeeping software now available. This process often gets overlooked because the owner is too busy “running” their business to have time to do it. The owner needs to ensure that this process gets done so that they have vital information regarding the financial management of their business.

Accounting. This is the process of taking the bookkeeping information and putting it into a format that can be used by the owner, to make sound financial decisions, or by parties outside the business such as banks, investors, or government agencies. The owner can use the information in any type of format that is meaningful for decision-making purposes. 

The outside user will want to see a standard financial statement that is prepared according to Generally Accepted Accounting Principles so that they can make an informed decision whether to loan to or invest money in the business.

If the business ignores this step and doesn’t have a proper set of books, the remaining tips are virtually meaningless.

Tip 4: Use the Financial Information

Once the owner has a proper set of books and meaningful reports and information, they can use it to make sound business decisions. The primary focus should be on maximizing profit and managing cash flow but planning for taxes and budgeting (discussed below) are also very important.  

If there is a profit, then the business can fulfill its purpose and is potentially worth pursuing. But just making a profit isn’t enough. 

The business must also generate sufficient cash to fund future operations and growth and to make sure that the owner is getting a fair return on their investment of time. One problem with cash flow concerns whether the business is allowing their customers time to pay after the work has been done. 

This is not an issue in cash businesses such as retail stores but if the business has to wait to get paid (accounts receivable) then the owner has to be aware of how long it is taking, especially if customers pay slowly, and making sure that measures are in place to collect the money. 

Likewise, an astute business owner will pay for items on credit (accounts payable) and wait to make payment until the cash from the sale has been received.

Tip 5: Stay Current on Taxes

Businesses are required to file tax returns and pay taxes. They are also, in some cases, expected to be tax collectors. In general, there are three types of taxes a business must prepare for:

Income taxes. How businesses and their owners are taxed for income taxes is beyond the scope of this discussion. However, income taxes are a fact of doing business and the most important thing to remember is to file tax returns and pay taxes on a timely basis (when they are due). 

There are two types of tax penalties, one for not filing a timely tax return and one for not paying taxes. The penalties for not filing are far more severe than those for not paying.

Payroll Taxes. If a business has employees, it becomes a tax collector. Both employers and employees are required to pay taxes each pay period and it is the responsibility of the business to withhold taxes and pay them to the IRS or the state taxing authority (if applicable). 

The same penalties apply, but payroll taxes are more problematic because the business is collecting and remitting money that is not theirs, so the taxing agencies are much stricter about filing and paying on time.

Sales Taxes. Retail businesses that collect taxes on each sale also require timely filing and paying.

Tip 6: Plan for Taxes

Tax planning is different than filling out and filing tax returns. Tax planning involves legally minimizing taxes by taking advantage of the complex tax laws and is done throughout the year, not after the year is over when nothing can be done.  

All businesses are entitled to deduct all ordinary and necessary expenses of conducting that business and it is in the best interest of the business owner to identify all deductions and credits they are entitled to. 

Tax planning also involves making estimated tax payments at required times to avoid penalties and big surprises on April 15th.

Tip 7:  Prepare and Monitor a Budget

Budgeting is a planning process that businesses should use both when considering starting a business and during the ongoing conduct of that business.

When starting a business, a budget is crucial to the planning process and the planning process is crucial to determining whether the business is worth pursuing. A budget is almost like a checklist that forces the prospective owner to identify tasks that need to be done and assets that need to be acquired to ensure the successful start of the business. 

It also projects the cash requirements necessary to properly capitalize on the business (we’ve all heard that the reason most businesses fail is that they weren’t properly capitalized).

Once the business has begun, the budget is also useful because if can be compared to what happened and allows the owner to take corrective action, if necessary.

Tip 8: Have an Exit Strategy

Just as it is important to find a business worth pursuing, it is also helpful to consider how the business will end.  At some point in time, it is likely that the business will be terminated, at least from the standpoint of the participation of the owner. 

This is more important in an entity that is designed to become apart from the owner than it is where the owner has created a job for themselves. In the latter, there may be little to sell or pass on. However, the owner of a larger business may want to pass the business on to employees or children of the owner or sell to another individual or an even larger company. 

In that situation, a value needs to be assigned to the business and it is likely, although there are many factors, that a good set of books will draw a good price and a bad set of books will not.

Small Business Finance Management Begins with You

The many factors in managing a small business. One of the most important is proper financial management. The owner must make sure that all financial matters are dealt with and this takes time, especially at the expense of operations, which most owners focus on first. 
A small business financial management expert, such as a Certified Public Accountant, can help the owner manage this side of the business.