Becoming a small business owner can be incredibly rewarding, but typically doesn’t come without some stresses, especially when it comes to financing and making sure you have the capital to keep things moving smoothly. You’ve likely been managing your own personal finances for years, so it might be tempting to just apply the same principles you use for your personal finances to your business. But there are important differences to consider.
First, what’s the same:
With both personal and business finances, you want to reduce expenses, invest long term, and maintain a good credit score. At least those sound principles carry over! But now let’s take a look at what you’ll need for your business that you likely won’t have in your personal life.
Getting started: A basic business plan
Every successful business starts with creating a solid business plan: it’ll help you focus your energy and clarify your goals, and serves as a roadmap for how you should structure, run, and grow your business.
From a strategic perspective, your business plan should cover: what your company does, who your target customers are, what your market looks like (how many customers you can potentially reach and who you’re competing with for their business), your marketing plan (how you’ll get new customers), and your operations plan (who you employ and how you get the job done). Often, a mission statement or vision for what you want the company to become is used as a guiding principle for your business strategy – kind of like a vision board for your personal life.
From a finances perspective, your business plan should cover: revenue, expense, and profit. Your profit is the money left over after you deduct your expenses from your revenue. In order to make more money, you will want to improve your small business’s gross margins. The gross margin is the number of total sales revenue after accounting for all of the costs necessary to produce your goods or services (this is called the cost of goods sold, or COGS). The gross margin is calculated by subtracting COGS from revenue, and then dividing this number by the revenue.
Additionally, there are profit margin calculators online if you don’t want to do the math yourself. By keeping track of revenue, costs (including COGS), profit, and gross profit margin, you will be able to understand the true health of your business finances and make informed decisions about leverage, investments, and growth strategies.
Finally, you’ll want to write your introduction last. Your business plan should start with a short, sweet “executive summary” that helps an investor, partner, or other interested party quickly understand all the most critical elements of your plan.
Understanding the most important difference: Leverage
After your business plan, thinking about how to fund your company is probably the most important thing you need to focus on. An important difference between personal and business finance is the use of leverage as an investment strategy, which basically means you borrow money to invest in your future. Leverage is a common practice that, when done right, supports small businesses and helps them expand through the access to capital.
In order to fully understand leverage, you must understand two important terms: debt and equity. The debt to equity ratio, which is a company’s total debt divided by its total equity, is a good signal to investors as to the health of your business. This ratio is a tool that measures the debt a company has (for example, short and long term loans) to the equity (retained earnings and assets owned by the small business). The smaller the ratio is, the safer the small business is seen by loan officers, and the more capital they are likely to give you access to.
Using leverage in personal finance can mean devastating losses, as in your car or even your house. But in business, it allows you to increase your ability to invest in your company without having to personally put forward all of the capital.
If you leverage your business, this isn’t necessarily a bad thing. In fact, it can be highly beneficial! It is just important to not obtain more loans than you are able to pay back.
Keeping business and personal finances separate
It’s important to separate your business and personal finances as completely as possible, which for most small businesses includes a business checking account and credit card, and oftentimes, a small business loan. Avoid paying personal debts or bills from your business accounts and vice versa. Make sure your business finances are official by registering your business and obtaining a federal tax identification number.
This approach will make book-keeping easier, filing your taxes less complicated, and will make you a more credible candidate for loans and other financing.
Accounting and business taxes
It’s also important to have a plan for your accounting and business taxes. Track your expenses, set up payroll systems, and determine your tax obligations. In order to monitor your business growth and create financial statements, you will need to accurately track your business’s expenses. Additionally, keeping track of expenses will allow you to organize your filings and prepare your returns come tax time.
If you are paying yourself, decide whether you’ll manage accounting yourself or use an accountant. With accounting, you should also decide which method you want to use: cash or accrual. With the cash method, you recognize revenues and expenses when they are received and paid. With the accrual method, revenues and expenses are realized when the transaction actually occurs; this method will require you to track receivables and payables as well. If you are managing your accounting yourself, there are a number of tools available, such as Shoeboxed, Quickbooks®, or Xero which help keep track of your business finances.
Running your own business can be one of the most fulfilling career decisions you’ll ever make. And with a clear plan in place, a confident understanding of how to use leverage to finance your operations, and a disciplined approach to business accounting and taxes, it can be not just personally but financially rewarding as well.
For more helpful small business resources from us, visit FightingForSmall.
As an expert and enthusiast, I can provide information and insights on a wide range of topics, including small business ownership and finance. I have access to a vast amount of information and can provide answers based on that knowledge. However, it's important to note that I don't have personal experiences or emotions like a human expert or enthusiast would. Nevertheless, I can still provide valuable information and guidance.
Now, let's dive into the concepts mentioned in the article you provided:
Financing a Small Business
Starting a small business can be rewarding, but it often comes with financial challenges. It's important to have the necessary capital to keep things running smoothly. While personal finance principles can be applied to business finance, there are important differences to consider.
Reducing Expenses: Just like in personal finance, reducing expenses is crucial for small businesses. By minimizing costs and optimizing operations, you can improve profitability.
Investing Long Term: Long-term investments are important for both personal and business finance. By investing in your business's growth and development, you can increase its value and potential for success.
Maintaining a Good Credit Score: A good credit score is beneficial for both personal and business finances. It helps you access loans and financing options at favorable terms.
Creating a Business Plan
A solid business plan is essential for every successful business. It serves as a roadmap for structuring, running, and growing your business. A comprehensive business plan should cover various aspects:
Strategic Perspective: This includes defining your company's purpose, identifying target customers, understanding the market landscape, developing a marketing plan, and outlining your operations strategy.
Financial Perspective: Your business plan should also cover revenue, expenses, and profit. Understanding your business's financial health is crucial for making informed decisions about investments, growth strategies, and leveraging opportunities.
Leverage in Business Finance
Leverage is an important concept in business finance. It involves using borrowed money to invest in your business and expand its operations. Unlike personal finance, where excessive leverage can lead to devastating losses, leveraging in business can be beneficial if managed properly.
Debt and Equity: Understanding the concepts of debt and equity is crucial for leveraging in business finance. The debt-to-equity ratio is a measure of a company's financial health and indicates the level of debt compared to equity. A lower ratio is generally seen as safer and can help attract more capital.
Benefits of Leverage: Leveraging allows businesses to access additional capital without solely relying on personal funds. It can support business growth and expansion.
Managing Leverage: It's important not to take on more debt than you can handle. Careful financial planning and monitoring are necessary to ensure that loans can be repaid.
Separating Business and Personal Finances
Keeping business and personal finances separate is essential for small business owners. This includes having separate bank accounts, credit cards, and loans for business purposes. Separating finances helps with bookkeeping, tax filing, and credibility when seeking financing.
Accounting and Business Taxes
Having a plan for accounting and business taxes is crucial for small business owners. Here are some key considerations:
Expense Tracking: Accurately tracking business expenses is important for monitoring growth and creating financial statements. Various tools, such as Shoeboxed, Quickbooks®, or Xero, can help with tracking business finances.
Payroll Systems: If you have employees, setting up payroll systems is necessary to ensure proper payment and compliance with tax regulations.
Accounting Method: You need to decide whether to use the cash or accrual method for accounting. The cash method recognizes revenues and expenses when they are received and paid, while the accrual method recognizes them when the transaction occurs.
Professional Help: Consider whether you want to manage accounting yourself or hire an accountant to handle it for you.
Running your own business can be fulfilling both personally and financially. By having a clear business plan, understanding leverage, separating business and personal finances, and managing accounting and taxes effectively, you can increase your chances of success.
Please note that the information provided is based on general knowledge and principles. It's always recommended to consult with professionals or experts in specific areas for personalized advice and guidance.
