Maintain Financial Balance When in Business

with No Comments

Running a small business requires financial balance. Assets should exceed liabilities. Income should exceed expenses. And what you gain personally from the business should exceed what the business gains from you.

A degree from Darden is helpful, but not necessary. You don’t even need a college degree. You just need to be willing to apply some of that high school math you learned and to know what you are looking for. Here are ten rules for small businesses to maintain their financial balance.

Don’t mix your personal money with the business’ money. If you are incorporated this rule is even more important. All cash flows in and out of the business must be carefully documented. Cash flows into the business constitute investments that can be paid back at a later time without tax consequences. Cash flows out of the business are distributions that either reduce your investment or remove profits from the business. If you co-mingle business and personal assets you can lose the legal protections that a corporation provides for personal liability.

Don’t neglect your own savings and investment. Many small business owners make the mistake of plowing all their profits back into their business. This leaves them with one asset, their business. Consequently, their personal financial wellbeing is completely dependent on the health of their business. Those who have taken the time to fund their own retirement can survive a business failure and emerge with their personal finances intact. You can always get another job or start another business, but you don’t want your life’s savings to go down with the ship. A personal financial planner can help you set up the right accounts and fund them.

Understand basic bookkeeping . Buy a simple program such as QuickBooks and spend the time and effort required to use it appropriately. Keep careful records of income and expenses and get receipts for everything. Without good financial numbers, you can’t make good financial decisions. There are many things in business that you don’t need to understand, but you do need to understand your corporate finances. The principles in the remainder of this article are all dependent on having kept and understood accurate financial books.

Know what it costs to produce what you sell. If you purchase a finished product for resale this is easy. If you have to assemble it yourself this is much more difficult. You need to include labor and overhead costs. If you are selling your personal expertise then you have to estimate how long it takes you and assign yourself a reasonable salary.

Know what it costs to sell what you sell. Once you have a product, there are still costs associated with getting it out the door. Advertising, marketing, labor, storage, and shipping all add to the costs of business.

Break your costs into fixed and variable costs. Fixed costs are those costs that you must pay no matter how many units you produce. Variable costs are costs that go up incrementally with each unit you produce. By dividing your costs this way you will see that the cost per unit goes down with every unit you produce. This principle is called the economy of scale. There is usually a point at which if you don’t sell enough you can’t be profitable.

Create a simple model of your cash flow. Cash flow is simply income minus expenses. Your model will also break expenses into four smaller categories: Fixed Production, Variable Production, Fixed Sales, and Variable Sales. Now you can build a model of your cash flow using the number of units. Each month the formula will be different, and you may want to have a separate formula for each type of item you sell.

With this analysis, you will be prepared to head off financial troubles. If your cash flow is decreasing you should be able to determine the cause. Are the fixed costs up or the variable? Is it because fewer units were sold? Having a cash flow model allows you identify problems before they are critical.

Don’t under-price your product. Determine what rate will produce a fair market value and don’t sell your time and effort cheaply. At a fair market value, some people will think you are over priced. At a fair market value, you will make more money with fewer customers. If everyone thinks you are a bargain, you are hurting your business. The market will quickly tell you if you are over-priced, but it is often more difficult for business owners to recognize that they are under-priced.

Spend appropriately on advertising. Some of the most expensive advertising is a wasted expense and some of the most effective advertising costs very little. Every business has to determine what works. Advertising needn’t be traditional media. If you can’t get people to come to your business, think creatively of how to bring your business to people. But whatever you do, don’t neglect time and effort marketing.

Listen to the markets. They will tell you what you need to know. Perhaps there is a single product that has a large profit margin or makes most of your revenue. It may have the potential to be a national best seller if you focused all of your time and effort on it. Many great companies stumbled on their primary business by accident. But they are great today because they were able to recognize what the markets were saying.

Gaining financial balance takes experience. Many multi-millionaires have prior business failures. Start by analyzing the business you currently work in. Then start imagining the finances of businesses you visit. Finally, start to develop a business plan for your dream business. Then consider making your dream a reality!

Photo by Cathryn Lavery on Unsplash
Follow David John Marotta:

President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.