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How to Beef Up Your Business Financial Literacy
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We’ve heard it all before, mo money, mo problems. But that doesn’t apply to us entrepreneurs and freelancers, right? I mean, mo money means we’re doing something good. Besides, who has time to review financial documents? That’s why we have accountants.
Well, I hate to break it to you, having a foundational grasp on your business finances is key to entrepreneurial success. Yes, even if you’re running from client to customer looking for that next buck, it’s important — nay, imperative — that you have the sound financial literacy to know what to do with that buck.
In this article, we’re going to explore five ways to build your financial literacy and do so without overwhelming you with facts and equations
1. Review your transactions, better yet make a budget
Let’s start off with some general housekeeping. I hope at this point in your entrepreneur/freelancing journey that you’ve opened a separate bank account for your business activities.
If you are currently mixing business and personal within one account, grasping your business financials is going to be a bit confusing. Also, sorting through your expenses with your accountant at year-end is going to be a nightmare.
If you’re looking for simple banking solutions, Novo is what I use for my business banking. They integrate with PayPal and Stripe and there are never any fees.
Okay, glad we got that sorted out. Now we can focus on honing our financial literacy skills.
The first step is simple but effective. Review your transactions.
Don’t laugh. Give it a try for a month. Every day, sit down for 5 minutes, log into your business bank account and look at what money is coming in and what money is coming out.
Why is this important? Well, I asked Alex and he told me:
“[Grant Cardone] said that money gets bored, and if it’s around too long, and you’re not paying attention to it, it’ll find somewhere else to go.”
They say a watched pot never boils. Well, a watched bank account never runs dry.
As you continue to monitor your daily transactions, a best practice to develop, according to Alex, is matching each transaction to a “source document” (receipts, invoices, etc.) that shows how that transaction originated. It’ll help your accountant at year-end.
As they also say: happy accountant, happy life.
2. Know your paperwork
The next time you want to know the difference between a balance sheet and an income statement, do yourself a favor and don’t ask an accountant. They will 100% geek out and spend the next half an hour talking about double-entry bookkeeping and the historical significance of the Gregorian calendar.
What I’ve done instead is put together a quick summary of each. Now, there are actually four main financial statements you should be aware of: balance sheet, income statement, statement of cash flows, and the equities statement. As a small business owner, you most likely will only concern yourself with the first two.
The Balance Sheet
The balance sheet is a high-level look at a business’s assets and liabilities, or in other words, what it owns, what it owes, and what’s leftover. Basically, it’s your business’s summary of financial status.
Accountants like to use this sophisticated calculation on the balance sheet: Assets = Liabilities + Equity
What does this mean? Think about your personal finances. What you own was financed by liabilities (loans, mortgage, credit cards) or by equity (cash, income, savings).
A healthy balance sheet — or strong balance sheet, as we say in the biz — uses a few ratios to determine its…healthiness (I’m running out of financial adjectives).
- Liquidity ratio = Assets/Liabilities | This tells you whether you can pay back your short-term liabilities. A healthy ratio is above a 1
- Debt-to-equity ratio = Debt/Equity | This determines if you are financing your business through debt or your own funds. Lower the better.
- Quick ratio = Current Assets (Cash, Invoices)-Inventory/Liabilities | This shows whether or not you can pay your short-term liabilities with cash or near-cash resources. Higher the better.
That’s enough math for now, let’s talk about the income statement.
The Income Statement
You might sometimes hear the income statement referred to as the “profit and loss statement” or the “P&L” if they’ve watched a bit too much Wolf of Wall Street lately.
Again using personal finances as an example, the income statement is sort of like your monthly checking account statement that your bank sends you. Your bank summarizes all the monies that have gone in or out of your account and you get a high-level view of its impact on your account balance.
Why is the income statement important? Because it shows whether or not you’re profitable. Are you earning more money than you are spending?
Now, if you are a solo-preneur and you’ve set up your S-Corp, chances are profitability isn’t your main goal (I dive a bit more into that in my previous article). However, knowing how much of a salary you can draw is determined by your income statement, aka it’s not wise to pay yourself more than you bring in.
3. Set up KPIs to align with your goals
I know, I know, most people pronounce KPI as K-P-I but wouldn’t the business world be a much better place if we pronounced it Kippy instead?
Pretty good, right? Save your enthusiasm for the time being, we can put a pin in the discussion and come back to it later.
In the meantime, we should talk about what exactly are KPIs — sorry, Kippies — and how do they apply to your business.
KPI stands for Key Performance Indicator and is typically referred to as a metric. A metric is just a number without goals attached to it. For example, a basic metric could be revenue. Let’s say for this tax year you’ve earned $100,000 in revenue. Is that good?
Well, it depends on your goals. If your goal is to be profitable and you spent $200,000 to earn $100,000 then that Kippy ain’t looking so good, is it?
Let’s take a look at what makes a good KPI (yeah, now that I hear it out loud, “Kippy” isn’t doing it for me anymore).
- A KPI should lead to action. When you look at your KPI, do you know what action you need to take?
- A KPI should be simple to measure. If it’s taking you hours to drudge up the numbers, then is it worth it?
- A KPI is current. Can you make an accurate business decision with old data?
- A KPI is always tied to your main goals. Are you growing profits, increasing conversion rates, reducing your debts?
If you’re just starting out as a solo-preneur, pick a few simple KPIs to track such as revenue growth rate or gross profit margin. Don’t track for tracking sake, use them to make better business decisions.
4. Understand your tax implications
You may be tempted to think that because you are self-employed good ol’ Uncle Sam will go easy on you.
I’ve already gone in-depth about the merits of electing for the S-Corp to potentially save you thousands of tax dollars (all legal by the way), but I’ll quickly summarize here.
Being self-employed means you are responsible for the entire 15.3% cut of Social Security and Medicare tax. When you work a traditional W-2, you only pay half and your employer pays the other half.
When you take the S-Corp election, you essentially share the burden of the tax between yourself and your business.