Financial literacy basics for prospective small business owners

Written by Peach Capital

September 2, 2014

What should entrepreneurs be aware of before they decide to devote a considerable amount of time, effort and resources to a small business startup? Here are 10 financial literacy “hot buttons” for new entrepreneurs and prospective small business owners to consider:

1. Know your (and your family’s) tolerance for financial risk. There are no assurances there will be either short- or long-term financial stability, so everyone involved in the startup should have the emotional and financial capacity for a high level of uncertainty. Also, using personal savings, a 401(k) or other retirement plan as funding is a serious decision that one must carefully consider if there’s a potential for loss of funds.

2. Learn how a legal business structure can impact your future tax liability. There are different tax advantages associated with formal corporate structures that accrue to both the company and the owners, and tax law changes nearly every year. Discussing the available business structure options with a qualified accounting or legal professional can help determine the best course of action when forming the business.

3. Understand how much money it REALLY takes to start your business. Most all startup projections for revenue growth are too optimistic, expenses are underestimated, and anticipated breakeven timeframes are too short. A good plan is to double the projected cost to get to breakeven, and triple the timeframes.

4. Understand what startup expenses are crucial versus questionable. Focusing on expenses that directly relate to revenue generation is one of the keys to financially managing a startup. Every startup expense should answer the question: “How does this contribute to the bottom line and get me closer to breakeven?”

5. Learn when it makes sense to use business credit. Business credit should be considered only when the money can be used for either of two purposes: increase revenues or reduce the costs of doing business.

6. Understand the relationship between your credit history and business lending. Lenders are literally banking on the owner’s prospects for success, and how an owner has managed their own personal finances to that point is an important indicator. Even a compelling business plan may not overcome an owner’s poor or marginal credit history.

7. Learn how to record and track business income and expenses. Accountants can only work with what they see. If it’s not recorded, it didn’t happen. Accurate records enable a business owner to gauge the financial health of the business through the use of ratios and other financial measurements. Having at least a basic computer-based financial system and keeping up with regular data input is a must.

8. Learn how to read, interpret and use business financial statements. The income statement, balance sheet and cash flow statement each tell a different part of the story about the company’s financial condition. Together, they can be used to find company weaknesses and strengths. Ratios derived from various sections of the financial statements provide clues to where a business owner needs to implement corrective actions before a situation becomes serious.

9. Understand how cash flow keeps a business alive. A business can be profitable on paper, yet fail from a lack of cash flow. Without a solid foundational knowledge of such areas, a business owner is handicapped in terms of actually managing the company’s cash.

10. Understand the financial implications of a new hire. Two major questions should be answered before anyone is hired: “How will they enable the business to increase revenues? How will they enable the business to be more efficient?” Quantifying these areas will help determine if a potential new hire is really worth what you will pay in wages, benefits and training time. PB


Matt Varilek

SBA Regional Administrator, Region VIII

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