Understanding Your Finances: Key Terms You Should Know
When you’re running your own business, you have a lot of responsibilities, and it can seem overwhelming, especially when you’re first starting out. It’s easy to get caught up in day-to-day operations without taking a step back to analyze your financial situation. But as a small business owner, understanding your finances is fundamental to your success.
You don’t need an accounting background to effectively manage your finances, but you should at least be financially literate. To make sure you have the basics, we’ve outlined the need-to-know components of financial literacy for small business owners.
First things first, you need to create a budget. Doing this allows you to track your income and expenses closely each month to make sure you’re bringing in more money than you’re spending. A budget gives you visibility into your financial picture. Then you can identify whether you need to make adjustments to maintain a healthy profit margin. To get started, you need to look at your financial data from previous months (or industry standards if you’re just starting out), which helps you forecast your income and expenses so you can plan for the future.
Cash flow is the amount of money you have coming into and going out of your business, which affects your liquidity. As a small business owner, it’s critical to manage your cash flow so you can predict how much money is available to you at any given time. To help manage your cash flow, you should reference your cash flow statement, which is used to report cash generated and spent during a specific accounting period. Having this information helps you match up your income to when you owe money. If you have slower months, tracking your cash flow also helps you know when you need to set aside extra money, so you’re not left short when bills are due.
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Your balance sheet is like a financial snapshot of your business at a specific point in time. It reflects what your company owns (assets), what it owes (liabilities), and its net worth (owner’s equity). It’s called a balance sheet because it balances — your assets must always equal your liabilities plus owner’s equity. It may also contain data from previous years so you can track your company’s performance and figure out ways to improve in the future.
Profit and loss statement
A profit and loss statement, also known as a P&L statement, income statement, or revenue statement, is a financial statement that details the amount of profit or loss over a specific time period, usually a month, fiscal quarter, or year. While the complexity of this statement can vary depending on your business type, don’t let it overwhelm you. In its simplest form, the goal of this statement is to look at your total sales minus your total costs to determine your net income. By reviewing this document regularly, you can analyze changes in your bottom line and decide if you need to make changes to increase profitability.
When it comes to small business finances, there’s a lot to know, but understanding these terms empowers you to take control of your finances. If you can read basic financial statements, you can make informed financial decisions that help you successfully manage your business.
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