There are millions of businesses in the world today that sell a wide range of products and services.
When looking at the most successful, what key characteristics do they all share? Two main aspects make these businesses stronger than the rest. These businesses have a strong understanding of their business finances. They know exactly how they make money, where they spend their money, and how much they keep. Secondly, they have a plan to grow their business. They know where they’re going to get new money in the future. These two characteristics are paramount to building a successful business, large or small.
In sole proprietorships, the owner is allowed to co-mingle business and personal finances, so using a business card can help keep track of business expenses and separate them from personal expenses for accounting and tax purposes.
You should consider much more than which bank is close by or which one you’re currently using to manage personal accounts. Though there are many reasons to a select a business bank, one of the most important is understanding the bank’s overdraft fee policy.
By Chris Keller
Understanding Your Business Finances
Mastering the basics of business finance is often overlooked. There are a few key terms necessary to make sure you’re set up for success. These terms are Revenue, Cash Flow, Income and Profit. Let’s use a fictional example of a business owner named Joe who makes and sells umbrellas.
Revenue or Income
Revenue or Income is the amount of money a business brings in by selling a product or service. So, when Joe sells somebody an umbrella, the money he gets in exchange is revenue or income.
Cash Flow is the amount of cash a business has that is moving in and out. Understanding this is important as it gives visibility to where your business’ money is coming and going. Using Joe as an example, he would see cash flowing out of his business by purchasing raw materials to build his umbrellas, his shop’s rent, utilities and so on. He would also see cash flowing into his business by customer sales or accounts receivable (delayed payments
Profit is the amount of money a business has after it has paid all of its expenses. For example, Joe has to pay for materials to make his umbrellas. These expenses need to be subtracted from his total revenue to get his profit. The profit is the overall amount Joe has left over after he pays his bills.
Your Business Revenue Model
Knowing how your business operates and most specifically makes money is extremely important. Below, you'll see an example of a business model canvas. This is a framework that allows you to visually represent your business to get a full understanding of every aspect.
Your business revenue model represents how your company makes money and is a key component of your overall business model. Your revenue model represents the products or services you sell in exchange for money, and your business can have multiple revenue streams. For example, Apple doesn’t just sell hardware (iPhones, iPads, etc.); they also sell digital products, like apps in the App Store or cloud storage space. They also sell products online and in their stores. These are all examples of different revenue streams.
It’s important to evaluate a few different areas when you’re thinking about your revenue model:
Value Proposition: What is the value you provide that will make your customer purchase from your business versus another business?
Customer Satisfaction: Great customer service and addons or services that provide value will keep your customers around, which increases your revenue.
Marketing: How and where and to whom you market your business to will work to increase your revenue, if done correctly. Watch out for high marketing spend that doesn’t return on your investment, however. It’s good to test small and grow into additional marketing channels as your revenue allows.
New Revenue Approaches: What are new ways you can sell your product and create additional revenue streams? Businesses that find new niche markets or expand into other possible revenue streams will consistently have a healthy profit.
Effective Pricing: How you price your products will matter to your revenue stream.
Understanding Your Income Statement
Every business should have an income statement as it is the best tool to understand financial performance over a specific amount of time. These are regularly called profit & loss statements as well. Let’s break down what exactly is inside of an income statement and what it means.
Operating & Non-Operating
There are two key portions of an income statement: operating and non-operating. The operating area deals with revenue and expenses related to normal business operations during that specific period. Your revenue streams would be included in this section. As mentioned above, revenue streams are anything that your business does to make money.
Non-operating refers to actions that are not directly involved in the core revenue streams of the business. Any revenue not directly involved in the core business is considered non-operating. Some examples of this would be sales of property assets, gains from cash invested and gains from currency exchange (if you operate internationally).
Reading an Income Statement
Income statements can be simple in most business cases, but in larger companies they can be complex. Starting at the top of your income statement you have your revenue, cost of goods sold and gross profit. As a refresher, your revenue is the money you accept for a product/service, your cost of goods sold is what it costs you to make/complete the product/service, and your gross profit is what’s left. The simple formula is:
Revenue - Cost of Goods Sold = Gross Profit
To be successful, your gross profit needs to be positive which means you’re making money. Once you have your gross profit, you begin to look at your operating & non-operating expenses.
SG&A & Taxes
While every aspect of an income statement may not be included for every business, the two main factors that will be are SG&A and Taxes. SG&A stands for Selling, General and Administrative expenses. These expenses are for things like administrative office staff, utilities, computers and supplies. Essentially SG&A are any expense that is not directly associated with the sale of a product or service. Taxes are something that everyone is familiar with. From a business standpoint, your business taxes are what is paid to the government from your gross profit. These two expenses are subtracted from your Gross Profit.
The theory of income statements remains the same for every business as it is a document to help understand financial
performance, but every income statement isn’t made equal. There are many other factors that can go into a robust income statement and understanding how these work is a big step in understanding your business revenue and how to grow it.
Forecasting Business Revenue & Growth
Forecasting your business revenue and growth is paramount to the success of your business. It gives you the ability to have a clear line of sight into the potential future of your business. This planning will allow you to hire staff more appropriately and build an operational plan for the future.
Be Aggressive and Conservative
When forecasting your projected revenue, make sure you have two separate projections. One is conservative and one is aggressive. These cases can have different variables. For example, your conservative forecast may have you doing all of your direct sales yourself while the aggressive forecast will have direct sales people bringing new customers on board.
Pay Attention to Headcount
If you’re planning on hiring or have staff currently, look at the amount of work you have per customer or function. Compare this number to your conservative and aggressive revenue projections to understand how much (if any) staff you’ll have to add to execute the growth.
Know Your Expenses
One common mistake business owners make when forecasting their revenue is the neglect to have a handle on their expenses. Take the time to understand how and where you’ll spend your money before you think about how much you’ll earn. Splitting expenses into two categories is a good rule of thumb. Fixed costs like salaries, rent and utilities are one category and the second is variable costs which are things like cost of goods sold, labor costs and packaging. List out all of your expenses in each of these categories and see what you’re spending.
You can then make estimates against these costs to better understand what your gross profit will be in the future.