Small Business Money Management Guide
Here's What You'll Learn in This Guide
As a small business owner, how comfortable are you with terms like “cash flow management” and “profit-and-loss statements”? Knowing how to track income and expenses, and how to use that knowledge to better your business isn’t second nature to many entrepreneurs, but it’s essential to your business success. The good news is, it’s really not all that hard.
Over the next six sections, you’ll learn the basics of money management, from balancing your books to predicting your cash flow and planning for growth. By the end, you’ll see that managing your money isn’t nearly as complicated as it sounds. It’s just a matter of planning and good record keeping. And while it might not be a skill you thought you had, it’s one you’ll find surprisingly easy to learn.
Section I – How to Keep Organized Books
Proper accounting is the foundation of a successful small business.
Tedious as it might seem, keeping organized books is really more a matter of methodical discipline than strenuous labor. Once you’ve mastered it, the other facets of effective money management should all fall into place, and like any seemingly unpleasant project, it all starts with a plan.
Plan Your Accounting
Once upon a time, balancing books involved writing down every sale and expense in a ledger, and calculating how much money your company was making. But like so many things in the world, technology has made it easier. Programs like QuickBooks and Wave require you to only enter the dollar amounts and categories for income and expenses, and does all the organizing and calculating for you. Even if you don’t want to shell out for fancy accounting software, a simple Excel spreadsheet can be just as effective.
Once you’ve selected a program, the next step is deciding which method of bookkeeping you want to use. Essentially there are two methods:
- Cash – recording all revenues and expenses when they’re actually paid or collected
- Accrual – accounting for revenues or expenses when the transaction occurs, even if you haven’t paid the invoice or collected any cash
If your revenues are under $5 million, you can use either method. If they’re over, the IRS might require you to use Accrual.
The third and most important step is setting aside time to do it. Between all the other duties you have as a small business owner, this can often fall through the cracks. But setting aside an hour a week (that’s a non-negotiable part of your calendar) to organize your books will make the difference between being on top of your accounting and falling hopelessly behind.
Finally, make sure you keep ALL personal and business accounts separate.
It might seem tempting to dip into business accounts for personal expenses, since it is your money after all. But it will complicate your accounting in ways you can’t anticipate. Should you ever be audited, mixing accounts could increase your tax liability.
Resolve to be disciplined about recording every sale and expense in your spreadsheet or accounting software so that you never fall behind.
The first thing you’ll need to account for is income. It seems fairly simple to record how much money you have coming in, but unless every transaction you have is in cash, it’s far more complicated than just keeping track of your receipts. When you make a sale using any kind of credit other than credit cards (these are treated as cash) also keep a record of when the client is expected to pay. Understand that sales do not equal cash on hand, and if you invoice clients on a net 30 basis, you shouldn’t expect to have that money for at least 30 days.
Ensure all your invoices are accurate and keep those that are come due, and check every day to see who has paid and who has not.
If your business needs cash frequently, aim to have the shortest Days Sales Outstanding (or DSO) as possible, and offer customers discounts for early payment. As you’re checking on unpaid invoices, at some point you’ll need to determine if that customer is ever going to pay, or if those invoices need to be sent to collections. If that’s the case, you may need to take those sales figures off your ledger.
Expenses will also need to be recorded accurately, which can be a little more complicated than accounting for income. This is because things like large equipment purchases, interest expense, taxes and payroll can be accounted for in different ways, over a longer period of time. But in terms of keeping your books organized, it’s best to account for expenses as you pay or plan to pay them, so you know how much operating capital your company has.
So if you paid cash for a big piece of heavy equipment, record that as an expense for whichever month you bought it. Profits might seem to be affected, but ultimately you’ll be better organized. Along the same lines, if you finance a large purchase, account for the payments each month, not the overall cost.
Payroll should be handled by an outside vendor if possible, to ensure all appropriate payroll taxes and deductions are calculated correctly.
If you are paying overtime, make sure you’re recording which days and hours the overtime is happening so you can factor that into your cost of goods sold. Clearly establish who is an employee and who is an independent contractor, so you don’t run into tax issues further down the line, and make sure to review all payroll reports before your service processes anything.
Finally, keep track of where your money is being spent. Often times business owners might feel like business is booming, when in fact the bottom is dropping out because they’re not watching their expenses. Start every day by seeing what’s been recorded and how much cash you have on hand, this way, out of control expenditures can be caught before they become detrimental.
It might make you feel a little like a hoarder, but keeping files with all your receipts and expenses – even after you record them in your spreadsheet – will make all of your accounting exponentially easier. It’s as simple as keeping files of receipts and invoices by month, and separating them out as paid and unpaid. This will not only save your life in case you’re ever audited, it’ll also make referring to past purchases and sales a simple process rather than a days-long headache.
Keeping your books organized and up-to-date might not be your favorite part of owning a business, but it is the foundation you’ll use for future success. By knowing where you’re making money, and where all of it is going, you’ll be better equipped to make changes to improve profitability. It’s the essential framework for all effective money management.
Section II – How to Manage Bad Debts Using Credit Controls
Sometimes you have to sell someone a product and trust they’ll pay you on time. Which, as any small business owner knows, doesn’t always happen.
Bad debt can cripple a small business, and when your cash flow is adversely affected by customers who don’t pay, it can mean your bills don’t get paid. This can ultimately put you out of business. So how do you minimize your risk? Set up credit controls.
Why You Need a Credit Control Team
Getting paid is serious business. And to get paid, sometimes you need enforcers, or people who aren’t trying to make any friends and aren’t afraid to ruffle a few feathers. These people are known as your credit control team. Having them will create a payment culture of timeliness and consequence, and minimize your bad debts. To wit: a report from the UK-based Forum of Private Business found that businesses with strict credit control parameters were far more likely to get paid than businesses that did not. Much like anything in life, it’s all a matter of planning.
In a small business, you probably won’t have the money to hire a devoted credit control team. But you can make credit control part of some employees’ jobs, or even your own.
How to Establish Credit Controls
The first step is figuring out how you’ll qualify customers for credit. You may not have the time or resources to qualify every new customer, and for small, one-time orders it may not be worth your time.
Determine the threshold for credit approval, and design a credit application that fits your business.
Your approval process should also involve checking credit through a credit reporting agency, but that isn’t always enough. You might also want to ask for references from other suppliers and a bank letter stating the customer’s financial solvency. It’s not unheard-of for a struggling company to have a history of good credit, then once things go south their payment schedule does too.
Once you’ve gotten approval, determine what each customer’s credit limit will be based on expected sales with a comfortable margin for growth, say 50% higher than expected orders. This can always be amended, but better to start small to minimize your risk. Then establish payment terms, like net 30, 60, or 90, and establish clearly what the non-payment penalties will be.
After that, it’s time to draw up the credit agreement, a legally-binding document that covers all these terms in greater detail. Most businesses have a standard form, that can be amended in special cases. This may be a job for your legal team, but if you want to draw up the contract yourself to save money make sure it includes the following:
- Names of the parties the contract is between
- Price and payment terms (net 30, 60 etc.)
- When goods or services are to be delivered
- Returns policy and time limits on returns
- Specifics as to when ownership passes from seller (you) to buyer (customer)
- Any warranties or money-back guarantees
- Rights of cancellation or nullification of the contract
- Contingencies for disruptions to the order due to forces beyond either party’s control (natural disasters, government intervention, etc.)
- Civil suit jurisdiction. Basically, if somebody is getting sued, where is that lawsuit getting filed?
Once everything’s in writing, go ahead and make that sale. If you’re dealing with a big company – like selling to Wal-Mart for example – you might have to adhere to their credit terms instead. Just make sure your sales team knows that the credit control department has the final say on whether to make any sale on credit, not them.
Invoicing and Collection
Sending out a proper invoice isn’t just a paper trail to make sure you get paid. It’s another document laying out the details of what your customer is expected to do.
Invoices should include the goods or services sold along with price, payment terms, interest charged if applicable, and clear instructions on how to pay.
Once delivery is made, follow up with your customers immediately to ensure everything is satisfactory. This isn’t just good customer service; it also protects you from customers who claim orders were incorrect or damaged later as an excuse not to pay. If part of the order is incorrect, issue an amended invoice for only the correct part of the order, and ensure the customer’s money for that portion of the order is still due as agreed. Correct the problems as quickly as possible, and issue a new invoice for the remainder. Again, this will protect against customers delaying payment of the full invoice, when only part of it was incorrect.
Most accounting programs have reminders of when invoices are due, so you can follow-up with customers who have not paid yet. But always record immediately when an invoice is paid so you’re not hounding people who paid on time.
Of course, not everyone is going to pay on time, and it’s up to your credit control team to make sure people know they owe you money. Emails are pretty ineffective means of collections, as they’re easily deleted and often go to spam folders anyway. Phone calls are a far more effective tool, though with the advent of Caller ID those can be ignored too. Collection letters can also be effective, though they need to start out polite and friendly before using more forceful language.
Perhaps the most effective way of getting paid is refusing to issue any more credit. Your sales team may not like it, but if a customer has an invoice outstanding, no more credit should be issued until it’s settled.
If a customer still hasn’t paid, it may be time to send them to a collections agency. Agencies are highly effective, but will charge anywhere from 5-15% of the debt and may not be worth it for small outstanding balances. Especially since less than half of debts outstanding for six months or more end up being collected. And for larger unpaid balances, pursuing legal action might be your last resort.
Because business owners must be equally adept at collecting payment as they are selling products, the ability to exert credit controls is essential in good money management. When you’re getting paid on time, you have cash on hand to not only pay your bills, but invest in and expand your business. And you’ll have more time to spend on the fun parts of the job, rather than chasing down unpaid invoices. Planning ahead and creating a culture of timely payment will maximize your ability to turn sales into cash. Make the task of keeping your finances in order a whole lot easier.
Section III – How to Synch Customer and Supplier Credit Terms
Cash flow is tricky to manage, and perhaps the most frustrating part of the process is paying people when you still need to get paid. Offering credit certainly helps your business, but if your customers pay you on the 30th, and your bills are due on the 15th, you’re going to end up with a serious cash shortfall for the periods in between. So how does one remedy the situation? Synch up your credit terms.
Of course, this isn’t as simple as telling your suppliers you’ll pay them after all your invoices come in. They’re in business just like you, and might need that cash on hand earlier than you’d like to pay. Secondly, customers don’t always pay on time, and even if you’ve exerted the world’s best credit control, that’s not a guarantee of payment. Also, if your business is large enough you might be handling thousands of transactions, and synching all of those credit terms would be logistically impossible. So aim to have your accounts payable due the same time as your accounts receivable. But it will take more than that.
Negotiating the Best Terms with Your Suppliers
Though you can’t completely control when your customers pay you, you can control when you pay your vendors. First, when arranging payment terms with vendors, try and set payment due dates that coincide with when you expect to have cash on hand. Also, try to spread out large purchases over time, so if money isn’t flowing in as you’d hoped you won’t take as big a cash hit. When possible, inquire about getting discounts for early payments, so during those months where you do have cash you can save some money by paying ahead.
You might also see if suppliers can send you goods on consignment, where you don’t have to pay for them until they’re sold. Some companies will also hold parts of your order back, so you’re not paying for goods that take up space in your warehouse. It also significantly decreases the amount of money you’ll need to pay at once.
Finally, there’s factoring. This is where a bank or other lender loans you money backed by your outstanding invoices. These loans can carry higher-than-average interest rates, but can solve a cash flow problem if your suppliers and customers aren’t synched up.
As a last resort, you can use credit cards to make immediate payments if cash isn’t coming in. The interest rates can be exorbitant, but if you’ll have cash by the end of the month to pay them off it doesn’t matter. It will buy you time.
Getting Cash from Your Customers
The most effective thing you can do to ensure you get paid on time is set up proper credit control. Assuming you’ve done that, and still have issues with timing your cash flow, there are some other things you can do to try and sync things up.
First, don’t extend credit on a basis that has payments due after you pay suppliers. For example, don’t sell on a net 60 basis on January 1, when you have massive bills due January 30. This seems like common sense, but when sales teams are struggling to hit forecasts and longer credit terms are a major sticking point, this can easily happen.
Offer early payment discounts (like the ones you’ve negotiated with your suppliers) and cash payment pricing.
Much like a gas station sells gas five cents a gallon cheaper when you pay with cash, you should offer discounts for customers who pay on receipt. You can also set up automatic debits and recurring payments from your customers, so you’re paid the same time, every month. That way you can plan your cash flow with a little more certainty.
In a perfect world, every customer who pays on credit should write you a check for all they owe, a week before you’re scheduled to pay your vendors. That doesn’t always happen, so putting safeguards in place to sync up payments is crucial to managing your cash flow. Strive to time it out perfectly, but understand it won’t always work. And be sure to budget everything else accordingly.
Section IV – Setting up a Profit-Loss Statement, and How to Learn from It
Accounting and money management can get confusing, because different terms are used for the same thing (terms like “revenue” and ‘income”, as well as “gross margin” and “gross profit”). Don’t be intimidated when you see a term like “profit-loss statement”; it’s the same thing as an income statement. And while painfully simple to organize, it’s equally neglected for small businesses.
In order to properly manage your money, you’ll need to have a tangible record of how it’s being used, and you’ll need to write an income statement every month. Things change in business so fast, if you don’t have the numbers to see what’s selling and where your money goes, you might not be able to make changes to right the ship in time.
Types of Income Statements
For all practical purposes, there are only two types of income statements: Two-step and multi-step.
The two-step statement consists of two sections:
- Gross profit and expenses - This is made up of two sections: Income and cost of goods sold. Income (also called net income) is your total sales minus any returns, discounts, or other special deals you extended.
Cost of goods sold is your beginning inventory plus any inventory purchases made, minus your ending inventory.
You might also account for selling costs here as well, like sales commissions, administrative costs, shipping and other variable costs associated with selling. Subtract cost of goods sold from net income, and you have your gross margin, or gross profit.
- Expenses - This includes all of your other expenses for the period, like payroll, utilities, rent, advertising, insurance, cleaning, etc. Total those up and subtract that from your gross profit. There you’ll have your net profit before tax.
Multi-step statements aren’t complicated; they just go into more detail. For example, expenses are broken down into categories like marketing, technology, labor, operating, general and administrative and so on. Each category has a total, and when costs are rising you can easily see where most of your money is going. On the income side, multi-step statements break down sales into different categories as well - by product, region, salesperson and other categories.
Of course, income statements can include other things, like stock earnings, interest earnings, dividends, sales of equipment and other non-direct income. But in its essence, the income statement is a simple document, and shouldn’t be intimidating.
What About Big Purchases?
When you buy heavy equipment - vehicles, insurance policies or other big-ticket items that you’ll use over time - accountants often don’t factor in the entire cost during the period for which it was purchased. This is called “depreciation,” where the cost of the item is spread out over the life of its use, and deducted in equal parts as a line item labeled “Depreciation”. So if you buy a $20,000 bread maker and plan to use it for five years, it might be accounted for each month as $333.33 of depreciation of the asset. If you finance the item, the payment can be considered the expense.
What to Do with the Information
With a detailed-enough income statement, you can figure out a lot about your business. If you’re selling a wide variety of items, it can allow you to figure out which items are the most profitable, how effective your pricing is, and how efficiently your business is running.
Each month you can look at an income statement and compare revenues for different products. Ideally, a product should be sold for about 45% more than it costs to make, including cost of goods sold, administrative and selling expenses. If the price isn’t hitting that target, you’ll need to look at either raising prices or cutting costs. And if the market won’t allow for a price increase, the income statement can tell you where to cut costs.
An income statement can also show you where to best invest resources. For example, if you have a product that’s accounting for the bulk of your revenue, you might want to consider investing more in the expenses involved with that product to increase profitability. On the flip side, if a product is costing a lot and bringing in very little, you might look to discontinue it.
Ultimately, your gross profit should be at least 30% of your net income. And if you’re not achieving that goal, it’s time to look further down the statement to see where you can cut back.
You can also use an income statement to see which customers deserve the most attention. For example, devoting resources to servicing customers who don’t produce much revenue isn’t the most efficient use of your funds, while giving great service to those who spend the most is. This is much like the service first class customers receive on flights versus those in coach. Other companies use this method as well. For instance, when you enter your account number at the beginning of a customer service call, that’s how the company knows whether to send your call to the VIP service desk or a call center.
Again, don’t be intimidated by a profit and loss statement. It’s a simple, crucial tool that gives you an overview of how your business is performing. It allows you to invest your resources more effectively, cut expenses where you must, and prune your product line to focus on what’s most profitable. Managing your money is nearly impossible without one.
Section V – How to Forecast Cash Flow
Forecasting is not an exact science. If anyone could accurately predict the future, he or she would make billions in the stock market, and probably not toil away running a small business. However, you need to plan ahead, and one of the most important places to do that is with cash flow. The actual cash you have coming in and out is not the same as profits, and when it gets overlooked, seemingly profitable companies go out of business.
Synching your credit terms between customers and suppliers – as was outlined in section three – is a necessary first step in accurately predicting cash flow. As is establishing strong credit controls. With that framework in place, it’s far easier to forecast how much cash you’ll have on hand for the coming year. But it takes a little more to do it effectively.
Look to the Past to Predict the Future
The best indicator of future performance is past performance. So if you’re an existing business, the first thing to look at is how much money you brought in during the previous 12 months. Look at where you expect your sales figures to lie in the coming year, and what trends might affect that. Did you make a lot more money in the summer than the winter? Were the holidays particularly strong? When mapping out a yearlong cash flow forecast, factor all of that in.
Also consider any new product releases or expansion plans for the coming year and the influx of cash you’d expect that to bring. If you’ve kept a cash-flow record from the previous year, look at that too to see when customers are paying. If most of your sales are net 30, assume about 90% of that cash will come in a month after it was sold. But it’s crucially important to look at when cash comes in, and not when goods are sold, to make an accurate prediction.
Then look ahead to any other cash that may be coming in, like an outstanding loan you expect to be paid, or the sale of equipment. Maybe you’re expecting an investor to step up, or you’ll take out a loan yourself. Add all that to your cash projections during the appropriate months.
Now, much like you did with cash in, look at your records for cash out over the past year. Unlike an income statement, you can’t factor in depreciation for large purchases. If you paid cash for something big, that’s cash outflow for that month. If you’re making payments, that amount is the outflow. Also, look ahead and factor in things like equipment repairs or replacements you’ll anticipate, loans that must be paid off, one-time fees, investments, tax increases, and months with three payroll periods.
You must also look back at how much of your accounts payable you pay off each month. It’s sort of like the flip side of sales: you might owe more than your cash outflow, but you only have to account for what you’ll pay. So if you have suppliers you pay over longer periods of time than others, think ahead about whom you’ll pay and when and record that in your forecast.
If you’re a service company, this is what you’ll need to make as accurate a prediction as you can. However, if you have a company that sells goods, you’ll also need to anticipate inventory purchases as they relate to sales. For example, if you see your cost of goods sold for last June was $5,000, you’ll need to anticipate at least a $5,000 cash outlay for May so you have enough inventory to cover your orders.
For new businesses, of course, this will be impossible, and all you can do is look ahead at how much cash you expect to be paying every month. At the very least, it’ll give you an idea of how much cash you’ll need to bring in to keep yourself afloat.
Then comes the most important part: Analysis. Your predictions will never be 100% accurate, so at the end of the month always look back to see if you were off, and why. Did you not account for a major purchase? Did supplier prices go up? Are customers not paying you on time? Predicting cash flow is great to help you stay ahead, but it’s equally as valuable as a way to see where your business can improve.
At month’s end, add a month to your 12-month prediction to try to figure out where your cash flow will be in a year’s time.
Doing this not only keeps you on top of your cash, but gives you ample time to prepare for any potential shortfalls. This is an essential practice for effective money management.
Section VI – How to Manage Growth
If your business is successful, it’s going to grow. The problem is, if you don’t know how to grow correctly, a successful business can quickly become a non-existent one. And your brand can go from being small and well-respected to unprofitable.
Like everything we’ve discussed with money management, successful growth is dependent on planning. Becoming a bigger company doesn’t mean doing the same things on a larger scale. It means adapting how your business operates to keep up with demand.
Before you think about serious expansion take a long look at your income statement and see why you’re doing so well. For instance, do you have one large customer that’s accounting for a big spike in sales? If so, can you keep up with its demand with existing facilities? Also look at the market as a whole. Maybe you sell craft beer and have seen sales rising because EVERY craft beer is getting popular. If your industry is still in a growth phase, see how much longer that’s going to last. You may also have a single sales person who’s driving your growth, or have no competitors in your market. While you’d like to believe your revenues are all due to great product and brilliant management, you may not need to expand if other factors are in play.
Also, look at how much your business is spending to acquire new customers. You might think adding more customers will equate to profitable growth. But if your numbers say that acquiring a new customer costs more than your cash reserves can handle, you’ll need to either look at financing or put off expansion until you can afford it. Maybe that customer pays for itself over a year or so, but if you’re operating at a loss for that year you might be out of business before you see any returns.
Lay the Right Framework
If your company expands, so will your organizational structure. A good first step is to lay out an organizational framework for a new, larger company.
For instance, if you’re adding a second or third location for your store, how will the hierarchy look at each store? And who will those store managers report to? Also, examine the policies and procedures you currently have in place, and figure out how those will carry over to a larger organization. You may need to create new positions, or delegate some new responsibilities to existing people. Having a more-rigid system of procedures may take away some of the organizational flexibility you’d enjoyed as a tiny startup. But it will ensure that when you expand, your products and service don’t suffer.
Plan for Service, Quality Control
No matter what, never stop listening to your customers. As you expand, it’s especially important to monitor social media and your customer service outlets to see if anyone is noticing a drop-off in service. If they are, address it immediately, and put new procedures in place to ensure your customers don’t feel neglected. If that means hiring more customer service representatives, do it. If it means calling disgruntled customers yourself, you need to. The first sign of a small business that’s expanded too fast is a drop-off in service, the venerable canary in the business-failure coal mine.
The next telltale sign of poorly planned expansion is a decline in quality. Before planning any growth, plan how you’ll handle quality control (QC) with increased production. You might need to designate a manager as a quality control expert, one who examines your final product to ensure it’s done with the same care it always has. You cannot afford to be reactive when it comes to QC. So as you’re laying out your new organizational framework, make sure QC is a big part of what you’re doing.
As you work on growing the business, you’ll inevitably need to install managers who can handle daily operations that you once did. But don’t be in a rush to hire new people to facilitate your growth.
Before hiring anybody new – especially at a management level – look to see if your increased revenues will pay for that employee.
If you need someone to man the store while you’re out prospecting investors, do so. But those investments need to pay that manager’s salary and then some. You may also want to look at your existing staff, and see if anyone there could step into a management role.
Once you do hire someone, it’s important you trust them and not micromanage the process. Taking the extra time to find the right fit will free you up to work on the business, and save you the stress of ensuring everything moves smoothly. If you’ve laid out your policies and framework well, your new managers will carry on like nothing ever happened. And hopefully that process can continue as your business continues to grow.
Finally, pay special attention to your income statement and cash flow. As good as you feel about your expansion, if it’s losing money, you need to quickly determine the reason. Even the best-laid plans can go awry, so scrutinize your books even more than you did in the past. And if the rapid expansion you’d dreamed of is becoming a rapid drain on your finances, it may be time to rethink how big you’re getting.
Growing a small business is hard, and doing it wrong is where many of them fail. But if you plan ahead, create the appropriate infrastructure, and pay close attention to the quality of your product and your level of service, you’ll give yourself the best chances for success. Maybe somewhere down the line, you won’t ever be a small business again.