No matter how brilliant your business idea, your company won't soar without money beneath its wings. Even businesses that have money coming in by the truckload have gone belly up because they didn't manage it properly. Business finance is the art and science of managing it so the lights stay on.
Business finance is the category of business skills that involves managing your company's money. The types of finance include investing, borrowing, lending, budgeting, saving and forecasting.
Definition of Business Finance
You need money to start, run or expand your business. Even with a good staff and good products to sell, this can be challenging, particularly when you're first starting out.
If your company is a sole proprietorship or a small startup, the financial decision-making probably falls on your head. In larger businesses, a dedicated financial manager or a finance committee handles the big decisions about business finance. Lower-level staff handle the routine details such as formulating the month's cash budget or filling out the paperwork to apply for a line of credit.
There are many types of finance issues in business, and you may have to deal with all of them at some point. Finance categories include investing, borrowing, lending, budgeting, saving and forecasting. Business finance involves decisions such as whether to apply for loans or grant funding or sell an ownership stake in your business to raise money.
The Importance of Finance
Even if your company isn't struggling and sales are spectacular, business finance is vitally important. If you don't exercise good financial management, you can yank the rug out from under yourself.
- When you forecast future sales revenue, it's easy to be optimistic, especially if sales are growing. An unrealistic forecast can leave you counting on revenue that never materializes. Good business finance requires realistic sales and budget projections. Learning you'll have to tighten your belt for the next year may hurt, but it's better than overspending.
- You'll have to spend some money on your business, but be careful of overspending. Buying new equipment or signing a lease on a fancy office can be seductive, but it's a mistake if the money's not there. Set a budget for rent, office equipment, travel and other expenses and then stick to it. This is one type of business finance know-how that even a one-person shop needs.
- Sales for which you haven't been paid contribute to your income but not your cash flow. If you don't actively manage your accounts receivable, you could end up dangerously short of cash. You can't stay afloat giving employees and utilities IOUs, so budgeting for cash flow is another vital skill.
- Not giving yourself a cash reserve is a business finance risk. At the same time, holding too much cash in reserve can leave you short of cash for investing in the business.
Types of Finance Skills
There are several different types of finance skills you'll find worth mastering or worth paying someone to use his expertise on your behalf. It may be that you'll have to do it yourself at the start, but as your business grows, you'll find a better use for your time.
- Business finance loves ratios: debts to assets, assets to current liabilities, profitability ratios and activity ratios measuring, for example, how quickly you collect accounts receivable. It's easy to apply the ratio formulas and crunch the numbers but harder to interpret what they mean for your business.
- Expanding your business involves risk, as it's not always easy to pare back your increased costs if things don't pay off. It takes good judgment to calculate the point at which expansion pays off versus the point at which you start to lose money.
- Financial forecasting is an area that really shows the importance of finance. You need to forecast sales and sales revenue, the output of goods or services you'll need to meet the demand and what effect that has on your cash flow and your operations.
- Budgeting for the coming year starts with financial forecasts and then gets into the nitty-gritty. If, say, your business slumps in the spring and spikes in the summer, you know to budget expenses and staffing accordingly. You also know your cash flow will decline and rise through the year and that you should budget for cash spending and reserves to balance that out.
- If you need outside support, business finance weighs the pros and cons of the different options. Possible sources include government grants, loans, selling equity in your company to investors and crowdfunding through Kickstarter or similar platforms.
- Keep your tax bill in mind. You may have to pay payroll tax, self-employment tax, corporate tax, sales tax, personal income tax or some combination of them all depending on the nature of your business. Taxes can make a huge difference to your net income, so factor them into your budget.
Sensible Finance Moves
Business finance involves plenty of number crunching, but a good deal of business finance is just plain common sense. Imposing and following some basic rules will make it easier to sit down and figure out the tough stuff.
- Keep track of your records. If you're looking for outside funding, you'll need detailed financial records to show lenders or investors. Even in house, it's important to monitor things like how long your accounts receivable have gone unpaid.
- Keep your personal finances and your business finances separate. It's really easy to confuse the two and lose track of how well your company is performing. If you're a corporation or limited liability company, it's legally important to separate your money from your company's money.
- Review your budget, your forecasting and your cash-flow projections regularly. If circumstances change, such as a new competitor entering the market, your projections need to change with them.
- Consider all your options when you're looking for financing. Different lenders may offer different terms, different repayment options, different interest rates and different late-payment penalties. Some may require collateral, while others won't but will charge higher interest. Find the best deal for your company.
- Keep your estimates of income, cash flow, spending, sales and everything else as accurate as possible. It's a common mistake to underestimate your monetary needs and overestimate your revenue. The importance of business finance is giving you a realistic view on which you can build a plan.
- Cut your losses. Clients who nickel and dime you to death or new product lines that don't earn what you need them to earn may not be worth your time. Set benchmarks and drop business that doesn't meet them unless there's a fringe benefit, such as having a prestigious firm you can name-drop as part of your clientele.
- Be careful about using your credit cards. They are a way to pay for business needs, but the interest rates are often high, and you will have to pay the lender back down the road. If you can pay off the bill in a month or two, that's great, but carrying a balance month after month will cost you.
- Cut costs. If you can run your business from home or a co-working space, there's no need to rent an office of your own.
- Don't throw away money. If your financial projections say the business isn't salvageable, it may be that the best thing you can do is close your doors.