business finances

Understand Your Business Finances Better by Answering These 5 Questions

A business owner faces many pressures, concerns and challenges and, perhaps, the biggest concerns revolve around money. Without it, the business can fail, creating a domino effect that can affect everyone involved in the business, including you — the owner. This is why understanding your business finances is one of the most important aspects of being a successful business owner. The good news is that you don’t have to be an accountant to successfully manage your business finances.

If you’re looking to better understand your business finances, you must ask yourself these five questions regularly so you can make good financial decisions today and have better outcomes moving forward:

What are my financial goals?

Whether you’re just about to launch your business or if you’ve already established it, you need to know what your financial goals are. What do you want your business to look like in the next few years (e.g., three, five or 10 years)? How much do you project your business will earn at the end of these periods?

Having a long-term idea of where you want your business to go will help you stay focused during the day-to-day grind of running your business. Knowing your financial goals will also keep you on track as your business grows, when you encounter new challenges and even when unexpected crises hit. It also helps you communicate clearly with investors and staff and build a transparent business.

What is my business’ current cash position?

It’s important that you know your business’ daily cash position. It not only helps you understand the ebbs and flows of cash in your business, but it also helps you understand your ability to manage your business finances day to day.

Why is this important? By understanding the ebbs and flows of cash in your business, you can, for example, better determine if you should add new products and/or services to help even out cash flow. On the other hand, if you have cash surpluses, you can better determine when and where distributions are necessary. You’ll also know how much money you have available when you need to reinvest in operations.

Understanding your business’ cash position is crucial in managing a successful business. Make sure to review it on a daily business or, at least, on a weekly basis. You’ll be surprised by how much you’ll learn about your business finances when you start regularly monitoring your cash position!

Do I receive a weekly cash flow forecast that gives me visibility of my cash inflows and outflows?

For some businesses, this question is important; for many, it is absolutely crucial. Like most business owners, you’re probably already aware that cash is the lifeblood of any business. So, if you want to better monitor your cash inflow and outflow, having a cash flow forecast is really important. Unfortunately, not many business owners are doing this.

What exactly is a cash flow forecast? Essentially, weekly cash flow forecasts are used to project a business’ liquidity over the medium term. It is used to estimate the amounts and timing of cash inflows and outflows. Why do it on a weekly basis? This weekly interval forces business owners to better understand the details of their business at a more specific and granular level. For instance, your cash inflow could be high one week if you collected a large amount of receivables; however, your outflows could be enormous the next week if rent and payroll are due. By monitoring your cash flow on a weekly basis, you can easily capture the seemingly small movements you would’ve otherwise missed.

Here’s a quick guide on how to create a weekly cash flow forecast:

Set up a spreadsheet. Then, add week-ending dates across the top. On the left-hand column, make rows for cash receipts and expenditures. Fill in three to four weeks of actual data to create a trend, then project from there.

Understand how your business collects cash and makes sales. You can choose from four general business models: hybrid, one-time lump sum, recurring and contractual.

Focus on cash payments. Then, schedule out fixed payments and what dates they must be paid by. Then, organize vendors into critical and non-critical vendors (you’ll be paying critical vendors first). Then, subtract disbursements from cash receipts for net cash flow. If there are shortfalls in the week-end cash balance, you can either figure out how to decrease disbursements or increase receipts.

For further example, you can review this 12-week cash flow model from CashAnalytics.

There are many reasons why business owners aren’t using a cash flow forecast. These can include not knowing how to do it, assuming it won’t be accurate, finding it tedious to maintain or, maybe, they simply haven’t thought about it.

Nonetheless, it is worth doing. Having a weekly cash flow forecast gives you visibility of your cash inflows and outflows and is a great way to know if you’ve got a problem coming at you. Done right, it allows you to see your recent financial history. Plus, it provides you with data to make informed decisions and will give you some insight into the future so you have time to react to problems.

Sometimes, business owners mistakenly conclude that because activity (production, sales, etc.) and profits are high, that cash will automatically take care of itself. However, this is not always the case. Even though your business may be profitable, cash flow can still be tight.

This is why — regardless of your cash situation — you should implement a weekly cash forecast. It’s amazing how much more in control and confident you’ll feel about your business finances when you consistently do it! 

Are my financial statements accurate and useful for making business decisions?

For a growing business, understanding financial statements — and what to do with this information — can be the difference between success and failure.

To make good business financial decisions, you need to understand your numbers inside and out. This comes from having timely, useful and accurate financial statements — and enough understanding to act based on this information. Financial statements aren’t just a grading system or scorecard that you get after one period is over. Instead, you should use them as a tool to generate the outcomes you want.

Many business owners simply don’t know how to read and interpret financial statements, and it’s really not their fault. Business owners aren’t necessarily required to learn these things. However, regularly reviewing your financial statements and understanding them can help you out a lot.

The financial statements you need to make good business decisions aren’t necessarily the CPA-prepared GAAP financial statements (generally accepted accounting principles). Instead, you need practical, run-the-business financial statements. Some of the financial reports you should review regularly include:

  • Budget vs. actual income statement
  • Year-over-year income statement
  • Key performance indicators/relevant metrics
  • Margin report (or contribution report)

Think of financial statements as the financial dashboard of your business. They tell you where money is coming from, where it’s going and how much you’ve got to work with. However, remember your financial statements must be timely and accurate to be an effective management tool. Without them, you can’t make informed business decisions.

How can I change my business’ pricing model to improve profitability and sales?

When thinking about financial growth, you should never forget to challenge your pricing model. When you fail to ask this crucial question and balance it with relevant market data, you offer your competitors the chance to outperform your business.

Here are some signs that it may be time to review your current pricing model:

  • Your cash flow is down. It may seem obvious, but keeping an eye on your cash flow can be an early indicator that you need to reevaluate your pricing strategy.
  • Discounts are driving your sales. Occasionally, offering discounts can be a great way to generate sales, but if you find yourself doing it more and more, it may be time to revisit your pricing model.
  • Your competitors are selling inferior services/products at an equal or higher price. If your competition is selling similar but inferior services/products at a higher price than you are, it may be time to rethink your value proposition and pricing model.

Key takeaways

As you read through the questions, how many could you easily answer these questions about your business finances based on your available data right now? If the answer isn’t all of them, it’s time for you to act. Getting answers to these important questions can help you make necessary decisions to run your business effectively.

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