Ongoing financial management is vital to ensure your business has the necessary funds to support its growth and sustainability. One of the key foundations of effective financial management is maintaining accurate and up-to-date financial records right from the start. These records provide valuable insights into your business’s financial health, enabling you to make informed decisions and take proactive measures to manage your finances effectively.
In this lesson, we’ll explore essential principles and strategies to help you maintain control over your business’s financial aspects. While the information provided here serves as a valuable starting point, it’s important to note that seeking professional advice from a qualified financial professional or accountant is crucial to tailor these practices to your specific business needs and ensure compliance with applicable regulations.
Keeping financial records
One of the foundations of effective financial management is maintaining accurate and organized financial records. These records provide you with a clear view of your business’s financial position and help you calculate important financial statements such as profit and loss (income) statements.
Before you commence your business operations, it’s essential to establish a system to record all sources of income and expenses. You have the option to manage your financial records manually or leverage online software solutions designed for bookkeeping. Regardless of the method you choose, it’s crucial to maintain consistency and record the type of income or expense accurately.
For instance, when selling an asset, it generates a one-time lump sum of income, while your regular transactions reflect your ongoing income. Similarly, purchasing an asset incurs a one-time cost, while regular expenses provide a more comprehensive overview of your ongoing expenditures. By categorizing and tracking these transactions meticulously, you gain valuable insights into your business’s financial health and can make informed decisions based on accurate financial data.
Digital accounting tools
Making predictions
Maintaining clear and ongoing financial records enables you to make accurate predictions about your business’s expenditure and income over a given period. These predictions are crucial for proactive planning, particularly when anticipating seasonal variations in trade where sales may decline or costs could rise.
Moreover, accurate financial records empower you to forecast profit and loss projections, providing insights into the potential financial outcomes of your business in the future. Such projections are invaluable for long-term planning and become especially important when seeking external finance or presenting your business to potential investors.
The method you choose for record-keeping will depend on your preferences and the nature of your business. Fortunately, there are numerous online tools available at little to no cost that can simplify the process. The key is to select a system that works for you and diligently maintain thorough records, especially if your business handles cash or electronic payments in large volumes.
Make it a practice to retain receipts for all business costs and expenses. Filing them regularly is much easier than trying to locate missing items at the end of the tax year. By maintaining meticulous records, you not only streamline your financial management processes but also ensure compliance with tax regulations and have the necessary documentation to support your financial predictions and claims.
Fun Fact!
82% of businesses fail because of inconsistent or insufficient cash flow.
www.smallbizgenius.net, 2020
Understanding business costs
To effectively manage your finances, it is important to understand the two types of business costs: fixed costs (also known as overheads) and variable costs.
Fixed costs
Fixed costs are consistent expenses that remain the same regardless of the level of business activity. While they are relatively easy to predict and account for, reducing fixed costs can be challenging. Examples of fixed costs include:
Rent or monthly mortgage costs
These expenses must be paid regularly, although they can fluctuate if interest rates change.
Licenses
Certain businesses, such as restaurants and bars, require licenses to play music or sell alcohol, which incur fixed costs.
Insurance
Premiums for insurance coverage on your premises and machinery are fixed for a specified duration, usually a year, but the cost can vary from year to year.
Wages for permanent staff
These costs are determined by employment contracts and can change as the number of staff members fluctuates.
Simplify daily bookkeeping
Variable costs
Variable costs, on the other hand, are directly linked to business activities and can vary from month to month. While they may be initially more challenging to predict, over time, you can gain a better understanding of their patterns. Variable costs can be adjusted based on business needs. Examples include:
Material costs
These expenses are tied to the quantity of products you produce or sell, such as the ingredients used in a food-related business.
Hourly wages for temporary staff
While the rate may be fixed, the number of hours worked by temporary staff will vary based on your business requirements.
Utilities
Utility costs are partly fixed since they are necessary for your business operations, but the amount consumed determines the variable portion of the cost.
Commission to third-party marketplaces
Online businesses may incur significant costs in the form of commissions paid to referral sites or marketplaces. Some businesses may treat these costs as fixed, depending on the nature of their agreements.
Need to knows...
- Business costs are those directly incurred in the running of a company, such as stationary, materials and equipment.
- Prospective costs are those that may occur in the future. These cannot be accounted for until they arise, but they can be predicted.
- Questionable costs are those that can be fixed or variable. This includes utilities, as the business must have them, although the cost of using them varies.
- Depreciation is the gradual decrease in the value of an asset owned by a business. It is a fixed cost, as it counts as a loss on a profit and loss statement.
