If you’re like most small-business owners, you may have gone into business because you’re passionate about the product or service you sell, and how it helps your target customer. While you may want to generate the highest revenue possible, you may prioritize excellence in serving your customers over managing business finances optimally.
Perhaps you’re also responsible for all aspects of business operations, so you might be one of the almost 80% of small-business owners who manage your accounting on your own, according to the 2022 State of Financial Literacy survey of 326 small-business owners around the world by business management software platform vcita. If you’re among the 60.7% of entrepreneurs surveyed who understand cash flow, financial wellness invokes thoughts of your business income and expenses, business account bank balances, and whether you have sufficient cash to keep your business afloat short term.
The numbers in your financials tell the story of your business. [...] But few people can look at those numbers and see if they have a problem.
—Paige Oldham, owner, Mindful CFO
If you have enough in the bank to keep your business running, and you’re making sales consistently, you might consider that financial wellness. But is that all there is to true small-business financial wellness?
What is financial wellness?
I interviewed three experts who have extensive experience helping small businesses generate consistent revenue and thrive in their enterprises. They defined small-business financial wellness in specific terms that go far beyond the data your daily business bank account balance provides. The trajectory toward consistent business growth may ultimately on your understanding of some basic concepts.
“Financial wellness is an understanding of where the business is financially and what the company goal is one, three, five, and even 10 years from now,” says Tar’kesa Colvin, master strategist at TColvin Consulting. “The first step is to be clear about and keep abreast of the current income, profits, expenses, and investments of your business,” adds Colvin, whose company supports established female small-business owners in overcoming the exhausting feast or famine cycle. “This is good data that supports future business decision making,” she continues.
Paige Oldham, owner of the Mindful CFO, a fractional CFO service provider, agrees. “Financial wellness is confidently knowing enough about the financial trends and financial position of your company so you can sleep well at night.
“Financial trends are tied to your company’s operational trends, like the number and types of customers you have, their purchasing habits and their customer service needs, and their production volumes and break-even points,” Oldham continues. “Financial position ultimately is your cash position: Do you have enough cash to support the expected ongoing operations and growth of your business in the current and future economic environment?”
That determines your business success, says Wini Stowe, IRS enrolled agent and owner of Winifred A. Stowe, an accounting and tax preparation firm. She asserts you’ll know when you’ve achieved financial wellness in your small business when you’re not struggling to keep the customers coming.
“Financial wellness is when your business develops a momentum that has customers or clients seeking out your services and products,” she explains. That means you no longer put extensive effort toward drawing customers to your business. “People know about your business, and they want your service or product,” says Stowe, who provides accounting for business growth for enterprises in multiple industries. Your business growth and expansion depend on your achieving this aim of word-of-mouth referrals. This is the road to consistent profitability, too.
But how do you get to that level? The first step is to consider applying some concepts of financial wellness to your business thinking. That may mean a mindset shift to help you understand the importance of structuring your business finances to generate the most profit from your enterprise. A small-business financial wellness mindset requires small-business financial literacy.
Do you have small-business financial literacy?
Just as it’s difficult to establish personal financial wellness without personal financial literacy, it can be nearly impossible to reach business revenue goals that lead to financial wellness without small-business financial literacy. That goes beyond knowing how much cash you have in your business bank accounts.
Poor financial management and lack of business financial literacy are among the leading causes of business failure. Many small-business owners simply don’t know how to generate revenue consistently, which is the basis for business expansion.
“Business owners must recognize their business operates to make money,” says Colvin, who works with business owners struggling to generate consistent revenue even after three years in business. “Your business is of no benefit to you if it’s not taking care of your financial needs,” she adds.
Small-business financial literacy may include understanding your money management style, financial planning, including budgeting and investing, knowing both your business and personal credit scores, and understanding financial statements and accounting. “The numbers in your financials tell the story of your business,” says Oldham. “But few people can look at those numbers and see if they have a problem,” she adds. Moreover, 54.3% of small-business owners don’t know their business credit score and 40.3% don’t have a detailed budget, according to vcita's 2022 State of Financial Literacy survey.
So, are you truly experiencing financial wellness as a business owner by simply having a bank account in the positive and paying business expense on time? To answer that question, business financial literacy may help you understand the financial position of your enterprise.
Your level of financial literacy and knowledge of the financial position of your operation, particularly specific to your industry, may define the financial fitness of your business.
3 Questions to Ask About Your Small-Business Financial Wellness
Consider starting by thinking about your long-term business goals through the lens of financial wellness. For example, if your strategy is to grow in the next five years, how do you position your business to do that financially? Knowing the answers to the following foundational business finance questions about your business will help you move toward this goal.
1. How am I managing my business expenses?
Are you paying all your business expenses and personal expenses from separate personal and business accounts? If you’re not, you’re probably comingling or mixing business and personal finances, which is inappropriate even if you’re a sole proprietor. Try to avoid paying personal expenses with business accounts and vice versa. Both Stowe and Colvin see this frequently.
Stowe gives the hypothetical example of a business owner who had $3,000 left in their business account at the end of the month. “They celebrate by moving the money to their personal account and going taking a vacation,” she says, “Then, when a business gets a bill equaling just over $2,750 the following month, they have no money to pay the bill.”
Many business owners will pay both personal or business expenses with the bank account where there’s money, but the money in your business bank accounts belongs to your business. “When you do that,” says Colvin, “you put your business at a deficit, and now you can’t meet its expenses.”
Stowe adds, “Also, when you need to submit your business financials to a bank for financing, it’s difficult to reconstruct them because of the mix of expenses in them.” Commingling makes it tough to track business expenses to determine if you’re profitable enough to get financing. She says small-business owners need to respect money. “Remember, you only can spend that dollar one time, and once you spend that money, it is gone,” she states.
2. How is my accounting system set up properly and do I understand its output?
There are multiple accounting programs you can use to record, report, interpret, and analyze your business financial information beyond invoicing. What you use depends on your business type, size and industry. If you’re a service industry business, like a communications consultant or writer with no employees, you’ll need a different accounting system from a restaurant or retail business that carries inventory and has employees.
Whatever you choose, it’s essential to make sure your accounting software or system gets set up properly to meet the money tracking needs of your business. So, you may need to hire a bookkeeper or accountant to help you construct the accounting records in your system correctly and keep them accurate. Make sure they understand your business type and industry.
Most business accounting systems generate the same output or financial statements—or they should, so understanding your accounting system’s output is imperative. For example, do you know the basic financial statement types and terms? Even if you have a bookkeeper or accountant, you must have a basic understanding of what these are. Here are the four financial statements you must know.
Income statement: This shows how much money your business has earned or lost, determining profitability. Also called a profit and loss (P&L) statement, it gives you a periodic snapshot of your business income and expenses—that is monthly, quarterly, or annually.
Balance sheet: This is a high-level view of your business's current financial health. It includes your business's assets (what you own) and liabilities (what you owe). Subtracting liabilities from assets provides the equity you have in your business.
Cash-flow statement: This tracks cash rather than profits, showing how cash is flowing in and out of your business through sales and spending related to your business operations, investing, or financing. You may be profitable and still run out of cash if you're not tracking your cash flow.
Bank reconciliation: This reconciles your entity's financial records with your bank balance, providing a rundown of deposits, withdrawals, and other bank account activities during a specific time period. These help ensure consistent records for borrowing and other purposes and to prevent fraud.
Having a firm grasp on your financial statements and the data they provide will help you make a growth map for your enterprise using key growth metrics based on these data.
3. Do I know important accounting terms?
There are many accounting terms small-business owners should understand, and accurate definitions of them are available from solid sources. But, Oldham also provides several terms small-business owners should know. Among them is the difference between accounting professionals. “A bookkeeper acts as a recorder of transactions, so sees things in black a white, and offers little to no planning or strategy support,” she explains.
“A CPA or controller puts transactional detail into financial statements, creates reports and analyses,” she says. An enrolled agent like Stowe can do the same, but also has authorization to represent you before the IRS. Many of these professionals, like Stowe, provide critical business growth help.
A fractional Chief Financial Officer (CFO) like her, Oldham says “provides long-term strategic thinking and planning, helps to lay the foundation for solid growth, looks at the big picture, and uses the financials to tell a story.”
Oldham also says it’s important to understand several other terms, too, like cash on hand (what cash or liquid assets are available to your business to meet unexpected business expenses). Also, know your break-even point, or when the cost of running your business is equal to the revenue you’re generating. Knowing your days of sales outstanding (DSO), the number of days it takes your business to get paid after a sale, helps you track revenue and profitability.
"But, it's important to know how the businesses in your industry pay so you can structure your operations around those payment cycles," says Stowe. She gives the example of government clients versus private sector clients. Though they pay reliably, the former usually takes much longer to pay than the latter. So you must determine if you can afford to take clients or customers with longer payment cycles.
“Business owners also must understand the difference between profit and revenue, because that’s crucial to business budgeting and operations,” says Colvin. Treating all revenue as profit, which is what your business has left after you subtract expenses from revenue, can leave your business cash-poor quickly.
“Tracking and documenting profit and loss consistently can change the way your business approaches revenue generation,” she adds. Knowing when your business expenses are payable helps you decide what the frequency and method of payment for products and services sold should be, so you have cash on hand for operations.
Understanding your accounting system, financial statements, and specific accounting terms are essential to things like getting operation or growth financing. They also can help you create a financial map of your business with key metrics that help you scale.
Manage Your Small-Business Finance Like a Large Corporation
Like corporate-level finance, small-business finance is a strategic discipline. Small-business owners don't pull financial levers at the scale Fortune 500 companies do. But understanding your business and its financial health is essential to helping you make solid business development, operations, and growth decisions.
Colvin, who works as a consultant to large enterprises, agrees. "Budgeting, setting financial goals, and strategic planning are tools large companies employ to generate profits," she says. "As a small-business owner, adopting and adapting these methods to your enterprise will positively affect your bottom line, increase cash flow and the ability to grow reserve accounts established for emergencies, like a global pandemic, and engage in the multiple other activities necessary for your business's success."
Image Credit: Getty
The information contained herein is for generalized informational and educational purposes only and does not constitute investment, financial, tax, legal or other professional advice on any subject matter. THIS IS NOT A SUBSTITUTE FOR PROFESSIONAL BUSINESS ADVICE. Therefore, seek such advice in connection with any specific situation, as necessary. The views and opinions of third parties expressed herein represent the opinion of the author, speaker or participant (as the case may be) and do not necessarily represent the views, opinions and/or judgments of American Express Company or any of its affiliates, subsidiaries or divisions. American Express makes no representation as to, and is not responsible for, the accuracy, timeliness, completeness or reliability of any such opinion, advice or statement made herein.