1. Use your financial statements to make business decisions.
What Financial Statements? We're so glad you asked.
There are 3 key financial statements that you need in order to complete necessary tax reporting, but also track the financial health of the business.
The cash flow statement is a statement that can show the inflows and outflows of money of your business. The more specific you are about the categories of income and expenses, the more this document will be able to help you see where you are earning the most returns, and where you may have room to cut some expenses to improve your cash position. Cash flow statements can be monthly or quarterly, but generally show a year of income and expenses. We find that businesses tracking monthly cash flow better understand the money in and out of their business.
The income statement is also called the P&L, or profit and loss statement. It shows the total revenue and expenses over a period of time, usually a year. The income statement also considers non-cash expenses like depreciation and unused inventory that aren’t captured in the cash flow statement. This statement shows the profitability or loss of a business.
The balance sheet is a snapshot in time of the business. It shows how much the business is actually worth, if you had to sell the business today. It’s referred to as the balance sheet because it is typically reported in two columns, where the assets are on the left and the liabilities and owners' equity are on the right. The equation is assets equal liabilities plus owners equity. The assets and liabilities are broken out into current, intermediate, or long-term.
The Cash Flow Statement
The cash flow statement shows you where the money came in, and where it went out, for each period. We find it’s easiest to track this monthly. The cash flow statement can tell you all kinds of information, but the information is only as helpful as the person putting in the information. If you’re just putting a general “SALES” category for receipts, and not breaking down by items or categories of items, do you really know what is selling when, or are you just trying to remember what you sold during certain times of the year? If you aren’t already doing so, maybe the first step for 2024 is to get more specific about your record-keeping so that you can use it to make decisions.
Nonetheless, you can ask yourself questions like:
- Were my hours and staffing sufficient? Are there times I could cut back on staffing during slower times of the year, or maybe cut “open hours” at certain times of the year to invest time in planning or production instead?
- Was cash sufficient throughout the year? Do I need to consider decreasing expenses or increasing revenue during certain times of the year to ensure I have enough cash on hand to meet my commitments?
- Are there opportunities to capitalize on increased traffic, like holidays, or nearby events?
For example, in the college town of Kutztown in Berks County, the students are on break during the summer, so businesses often decrease their hours. However, each late June and early July, the fairgrounds host the Kutztown Folk Festival, where thousands of visitors come to town for the festival. A business nearby could use their marketing funds to ensure they’re reaching those customers coming to town, or they could increase their hours for that week to reach those customers.
The Income Statement
An example income statement
The next financial statement to use is your income statement. This statement shows the business’s profitability, or lack thereof. In this example we see that the business had a sales revenue of $500,000, but we don’t know how they earned it. Maybe they sold $500,000 from the family orchard, but we don’t know if it’s in strawberries, blueberries, peaches, apples, or pears—that’s not a great way to track income.
However, our friends here did an excellent job breaking out all of their expenses. We know they spent about 25% of their sales on employee wages, which is not surprising, and they have $50,000 in depreciation, so maybe they have some newer equipment or buildings that they invested in for their business.
If, in the example, they were more specific about the sales, we could maybe ask what the greatest income generated was on the farm, and if there are additional opportunities to capitalize, like adding a value-added product to gain the most from that crop that we can sell during other seasons.
We can see that the greatest expense, though, is employee wages. Could it be decreased? While you’re thinking about this, you could think about the employees that you have. Are the right people on your team? Are you compensating everyone for their contributions? Do you need to bring in additional employees to meet the business's needs, so you need to budget MORE in this category? You can make decisions about budgeting from the income statement.
The Balance Sheet
An example balance sheet
Finally, we can take a look at the balance sheet. This statement will tell you, if you had to sell the business today, what it would be worth. As you can see there, the market value of all assets for the business on December 31, 2022, was $770,000. Likewise, because assets equal liabilities plus owners equity, the liabilities and equity also equal $770,000.
From this statement we can see if the business is liquid. There is only $2,200 in cash right now. The business may need to sell more inventory to convert that to cash to meet obligations. One the owner would know if the cash is sufficient.
Current assets are $89,000 and current liabilities are $61,000, so the business is able to meet all of its obligations at this time—the business is solvent.
However, we can see that there is $31,000 in inventory right now. For a small business, that may be a lot of inventory to have on hand at one time, depending on the type of business this is.
Only you, as the business owner, know the ins and outs of the business and can use the information in these statements to make the best financial decisions for the business.
2. Set goals and schedule time to check in.
The second recommendation is to set goals, and set times to check in on those goals. You’ve now considered all of the information you can glean from your financial statements. You know if you have enough cash or not, how much inventory you’ve currently stocked, if your business is profitable, and where money is flowing, and hopefully not white water rafting, in and out of your business. It’s time to set some year-end goals with profitability in mind.
Only you can decide how many goals is the right number for you and your business.
Commit to updating your cash flow monthly. This way, at least monthly, you can check in to see where the money is flowing in and out. You may have found that you need to be more specific about the way you keep your records, so updating monthly will help you learn more specifically about your money ebbs and flows. Or, if you are already keeping thorough records, you can make more timely decisions. For example, if a supply that you often use goes on sale, you can know if you have the cash available (not just in the checking account right this very moment—but know if you have the money budgeted in your cash flow that you will not need for a future bill) to take advantage of that sale.
Another possible goal could be related to a new product or service you plan to offer this year. For example, if you grow honey, you may have an idea to add tea from a local grower to your retail store. If the tea is not selling, or the markup isn’t great enough to justify the space/time to acquire, market, and sell it, you may say, "Well, I tried it, it wasn’t as profitable, and I’ll move on." Or, you may see that your customers love this adjacent project, and decide to offer other, similar products to your lineup.
The easiest goal to set is an income or sales-related goal. If your business sold $32,000 in product this year, maybe you want to aim for $40,000 in 2024. Checking in monthly to ensure you’re on track to reach $40,000 by the end of the year can help you adjust your marketing or distribution to help you get back on target to reach your goal.
3. Make a plan to manage debt and follow it.
Third, we recommend making a plan to manage your debt.
There are many ways to manage debt, but the two most common methods are the snowball method and the avalanche method. The snowball method is where you would pay off your smallest loans first, so you can check off boxes and have less people or businesses you owe. Some people feel more accomplished when they’re able to check boxes faster.
The avalanche method is paying off your highest-interest loans first. Some people are motivated to pay off debt with this method because they ideally will be paying less interest in their debtors if they check off the highest interest rates first.
No matter which method you choose, select the one that works for or motivates you.
If you’re lucky enough to not have any debt, it’s best to make or have a plan for if your business will need financing down the road. It is best to establish a relationship with a lender in your “good times,” than to be shopping around, and sometimes rushing around, to secure financing during the “bad times.” It’s also important to take time and foster a relationship with a lender who understands your business. Recently, a banker reached out because they had a farmer client. The farmer had a $600,000 line of credit that was on a variable interest rate, and during these times of high rates, the farmer wasn’t even able to meet the minimum monthly interest payment. If the lender had been a banker familiar with farming, they probably would have set up the debt as a term loan, so the farmer could pay a larger principal when the crops were harvested, which had a locked-in interest rate. But the farmer had come to this lender in a time of hurry and need, and the lender did what they could at the time, but ultimately, it ended up not being a good decision for either party. The moral of the story is please be prepared for financing debt before it’s an emergency and foster that relationship well.
4. Create and/or contribute to an emergency fund.
Establishing or regularly contributing to an emergency fund is our final tip to help you be financially prepared in 2024. Emergency funds can be stored in cash, in a checking or savings account at a bank, or in a prepaid credit card that only the funds contributed on the card can be spent. It is important that the funds are liquid—that is, they are cash or can immediately be used as cash in the case of an emergency. Most resources like the Consumer Financial Protection Bureau and Vanguard recommend having 3–6 months of business expenses in your emergency fund. Keep in mind, you may also wish to contribute to a personal emergency fund, separate from your business.
How to get started with a fund? It’s most important to be committed and consistent. An easy way for you to do this may be to set up an account with an automatic withdrawal to your emergency fund for each pay period. Or, you may take a percentage of revenue each quarter, and move it to a separate account that you’ve created for emergency use only. No matter what you decide, it’s important to keep contributing consistently.
If you as a business owner are living paycheck to paycheck, contributing funds to yet one more thing can seem daunting. The size of the contribution is really not critical. Having some funds set aside in the case of an emergency is always going to serve you better than having nothing.
Sometimes those who commit to an emergency fund are afraid to use the funds. The purpose of emergency funds is just that, to use the funds in the case of an emergency, like the loss of an income, a medical expense, or a car repair. When an emergency arises, use the funds, and then start contributing again when the emergency passes. The key is to remain committed and consistent so the funds are there again should another emergency arise.
We are here to support you as you grow your business. If you have additional questions about how to better understand your business's financial position, please email our team.
