Any business venture, regardless of size, starts and ends with finance. The financial aspect of doing business determines whether you have enough resources to purchase raw materials, invest in the necessary equipment, pay salaries to employees, work with business partners, market your product or service—the list goes on.
The good news is you don't have to be an expert or analyst to make sure your company can sustain everyday operations while being profitable. You simply have to know the basics in managing the finances of your business.
This infographic gives you a good head start with a top-to-bottom guide on understanding finance fundamentals and applying the concepts in the business setting.
What Is Business Finance?
Simply put, business finance is how you manage money for the company and its owners so that the business can be profitable.
The day-to-day functions of disbursing cash and collecting payments are part of business finance. Making financial decisions, such as applying for a loan, purchasing equipment, or going into an initial public offering (IPO), also falls under business finance. Even if the business is performing well, proper money management is vital in helping the company reach higher levels of success.
Fundamentals of Business Finance
Tracking the company's day-to-day finances and the overall financial position requires understanding these three business fundamentals:
Cash flow refers to the money moving through the business. Cash inflow is the money that the business generates, perhaps from product sales or subscription to services, while cash outflow is the money spent, such as for payroll or rent. A positive cash flow is when more money is coming in than going out, while negative cash flow is the other way around.
Obviously, from a business point of view, the ideal situation is to have a positive flow of money, as this builds up cash reserves for immediate or future investment. But since not all businesses can consistently pull this off, you should anticipate that there will be times when the company experiences a negative cash flow.
For instance, you may have outstanding invoices and need the services of companies specialising in invoice financing in Australia to help you manage your cash inflow better.
Alternatively, you may need to fix internal issues, such as excessive stock levels or operating expenses, which may be causing prolonged periods of a negative cash flow.
Liquidity refers to a business's ability to make on-time payments for all sorts of expenses—from office rent and maintenance to taxes and loans—using company assets. These assets include the organisation's cash on hand, which is considered a more liquid asset because it's readily available within the company, compared with office space or equipment that may take some time to sell and convert into cash.
One of the goals of business finance is to ensure that your business has the right balance of liquid and illiquid assets, as this means you can meet your payment obligations. Meanwhile, having little liquidity may cause you to default on payments and lower creditors' confidence in your company's financial standing.
Working capital or net working capital is the difference between a business's amount of short-term assets in excess of its short-term liabilities. Current assets may include accounts receivable, inventory, and other valuable items that can be converted into cash in a year's time. Similarly, any payments you need to settle within a year are considered current liabilities, so wages, income tax, and short-term debt or loans fall under this category.
A positive working capital indicates that the company has adequate financial resources to operate daily, while a negative working capital puts the business's liquidity in question.
However, it's possible that despite a positive working capital, the company still lacks the day-to-day cash inflow necessary to operate smoothly. This can happen if the company either has a hard-to-sell inventory or difficulty collecting from its accounts receivable.
In some cases, even though the cash inflow is high due to the company's inventory selling quickly, the working capital takes a dip from having too many accounts payable.
The bottom line is that a look at each of these factors—cash flow, liquidity, and working capital—is necessary to get a complete picture of your company's financial health. Plus, since each business is unique, you need to make a thorough evaluation of your company's situation before making finance-related decisions.
Financial Components to Focus On
Whether you're starting or expanding a business, it's a must to exercise effective and efficient business finance. In particular, you need to pay attention to these areas.
1. Financial Statements
Financial statements are vital documents that tell you how well your business is performing or otherwise. As such, you should learn how to read and use financial statements, which include the following:
Balance sheet - A valuable tool for existing and potential investors, the balance sheet summarises what your company owns (assets), what it owes to others (liabilities), and what it owes to the owners (shareholders' equity). Your company's balance sheet can also help you secure loans as it acts like a yardstick of your financial strength.
Income statement - The income statement is also known as a profit-and-loss statement. It shows the company's net profit and loss based on the summary of revenues and expenses. Use the income statement to track the record of your company's operations and measure the profitability of your business.
Cash flow statement - This helps measure the amount of time it takes for your business to recover the cash it has spent—a shorter length of time results in the company having enough money on-hand to operate smoothly.
2. Receipts and Payments
Keep tabs on company expenses so you can see where the money goes or where budget cuts may be possible. Your company's financial statements are the tools you need to monitor both revenue and expenses.
Bookkeeping involves the daily recording of all of your company's financial transactions in chronological order. Any money that comes in and goes out of your cash register must be recorded in your books. Should a discrepancy come up in your financial records, you can easily make reconciliations by pulling out the information from bookkeeping.
4. Human Resources
Human resources is a fundamental aspect in a business that needs financing in order to function and operate properly. Making your employees feel that they are prioritized in the company will lead to a more satisfied and happier work environment.
5. Tax Planning
Depending on the size, nature, or structure of your enterprise, you may be entitled to certain tax credits. This is where tax planning comes in. Designed to benefit businesses, tax planning can help save you money as you file for exemptions or exclusions in tax payments.
Your company may claim tax deductions from your individual taxes (applicable if you have a sole proprietorship business), business insurance, real estate taxes, and several others. The more tax credits you claim, the lower your taxable income becomes. You can then apply any savings toward your financial goals, whether it's for expansion, funding R&D, or any other activity to improve your bottom line.
Focus on Fundamentals
Proper money management plays a major role in business success, making it essential for you to understand business finance even at its most fundamental level.
However, every now and then, you may run into some aspects that require higher-level expertise, such as invoice financing. Earlypay is recognised for providing competitive options for companies trying to manage their invoice financing. Discover the ideal solution for your company.