Resolutions, new beginnings, a clean slate – the new year brings opportunities to refresh your strategies, clean up any processes that drag you down, and create good habits.
One area you might be considering for improvement is financial management, and you’re not alone if this is a mainstay on your list. While 94% of small business owners think their business is ready for the next 12 to 18 months, the reality is that more than half aren’t financially prepared for revenue shortfalls.
You can make it through any financial challenge with good business financial management habits. Explore the tips below and set a plan to implement them in the new year and beyond!
1. Identify your financial benchmarks
Before you set financial goals for the next year, you need to know where you are right now. Start by identifying benchmarks for your business. Benchmarks are the key metrics that show you how your business is doing now, and you can use them to compare how your business performs in the future.
Setting your benchmarks gives you a standard to measure against throughout the year. You’ll get more accurate insights into whether you’re effective at reaching your goals, and you can also use your benchmarks to create financial projections for your business.
Some typical benchmarks include:
Gross margin: Gross Profit ÷ Total Sales
This shows you how effectively your business is turning products and/or services into revenue.
Operating margin: Operating Profit ÷ Total Sales
With this, you can see how effectively your business is turning a dollar of sales into a dollar of profit after all expenses.
You may also want to explore liquidity ratios, which can tell you whether your business can cover your short-term needs. If you want a more in depth method for benchmarking your entire operation, you can try conducting a horizontal analysis and a vertical analysis, too.
Once you’ve identified your benchmark metrics, it’s time to analyze those metrics against your industry’s standards. You can find this information in IBISWorld market research reports or the Risk Management Association’s annual industry data. How are your benchmarks measuring up against the industry? If there’s room for improvement or you’re ready to grow your business, then it’s time to make a plan for how you’ll reach those goals.
2. Set goals to improve your profitability
Now that you’ve got your benchmarks, you can set goals to boost your profitability. What makes your profits increase? It’s pretty straightforward. More than likely, it’s one or a combination of these three:
- increasing your total revenue
- decreasing your cost of goods sold (COGS)
- decreasing your overhead costs
It seems easy enough: increase your revenue and keep your COGS and overhead low! But you know it’s not that simple. There are aspects of each of these strategies that are outside your control, and there are pros and cons to each approach. Here are a few things you need to consider:
Increasing revenue: Making more money is a surefire way to increase profitability and it’s less likely to compromise other parts of your operations.
But here’s the reality: growing your top line is the most challenging way to increase profitability because it ultimately relies on your gross profit margin. Here’s how you find that figure:
Gross Profit Margin = (Net Sales – COGS) ÷ Net Sales
If your business has a lower gross profit margin, increasing your revenues will have less of an impact on your bottom line. With a higher gross profit margin, your business will see a greater profit increase when you grow your revenue.
There are a few tactics you can use to increase your revenue in the new year. Do some research on a new market segment that’s willing to pay higher prices, and test some higher ticket items and services with them. You could also offer related products or services that carry higher margins to your current audience to see if there’s demand for them. These are great strategies for driving profitability through increased revenue.
Decreasing Costs of Goods Sold (COGS): It’s simple math: when the cost to bring your goods and services to market decreases, your profitability increases. This is the most effective way to increase your profitability in the long term. That being said, there are risks in using this tactic. If you lower your DOGS as well as the quality of what you’re offering, customers won’t be willing to pay the same price. And if you cut corners to cut costs, you also risk bringing inferior products to market.
This is a strategy you need to think about from every angle. Consider whether it’s worth switching suppliers for lower cost raw materials. Review your production process to ensure it’s efficient and not eating up your budget unnecessarily. And above all, make sure that any cost cuts you’re making are still in line with your business’s values. For example, if your business is known for being environmentally conscious and you switch your packaging to nonbiodegradable material, will it be worth the potential risk to your reputation?
Decreasing overhead: This is typically the go-to strategy for a business owner who needs to improve their financial picture. It’s not surprising: it’s the easiest and quickest way to grow profits. However, like decreasing COGS, you need to choose wisely when making cuts in your overhead.
Finding opportunities for operational efficiencies in your business will make you more productive and profitable. But reducing your labor force when you need the support or reducing wages can have a negative impact on your business in the future, even if you have short term gains.
3. Plan for major expenses
You can’t always anticipate when big expenses will pop up, but you can make sure you’ve got a solid financial foundation to take care of them. Surprises aside, there are other major expenses that can drive your business forward and build it for the future, and these are costs you can incorporate into your financial planning.
Start by creating a list of expenses that will help drive increased sales over time. Think about new equipment or upgraded technology to streamline your processes. Consider your current space: is now the time to expand or move from a lease to a commercial mortgage? Prioritize what’s needed most or what will have the greatest positive impact on your business, and start making a plan for it.
Unless you’ve got huge cash reserves for your business, you’ll likely need financing for these expenses either through a lender or an investor. The best time to apply for financing is months before you actually need it. It can take time for your application to be reviewed, approved, and then funded, so make sure you’re not cutting the timing too close.
Start your financing search and application prep three to six months before you really need the funding to make sure you have everything that’s required for a business loan application. You can get in touch with a lender today to find out what they require so you can start gathering documentation now.
4. Discuss your tax planning strategy with your accountant
While you’re getting a jump on tax season at the start of the new year, take some time to review your overall tax strategy with your accountant. Many small businesses take an aggressive approach to tax savings, falling into the trap of reporting zero profits or a net loss on their tax return to avoid tax liabilities. Did you know that this strategy can make it more difficult to qualify for credit when you need financing?
Don’t risk your business’s future just for a lower tax bill. Adjusting your inventory value in your books, over counting expenses, and/or underreporting revenue can get you into trouble with the IRS.
Remember, a lender will look at your reported cash flow to determine whether or not you can repay potential debt. If you’re not reporting revenue and expenses properly, it will appear that you can’t repay a business loan.
Consider a balanced approach to tax savings and creditworthiness when filing your taxes. Talk to your accounting and tax professional about reporting accurate revenue and expenses, and focus on “good” write-offs like depreciation and amortization. These write-offs can save money on taxes and won’t negatively impact your ability to access credit.
5. Commit to updating your financial records at least once a month
Here’s your goal for the new year: update your books at least once a month. Having up-to-date information gives you what you need to make better business decisions in real-time.
Think about whether you’ll need to hire employees and increase your bandwidth to reach this goal. Updated financials means preparing cash flow statements and income statement on a monthly basis, among other financial documents. You could hire a bookkeeper who works exclusively for you, or give the task to a team member with experience in managing business finances.
If hiring staff or delegating to your current employees isn’t possible, make time to do it yourself. It’s important for you to know how to produce internal financial statements so you have confidence that these statements accurately demonstrate your financial performance.
As a busy entrepreneur, reviewing financial records frequently might seem tedious, but this information gives you guidance and a way to measure your success. You don’t want all the work you put into your business to be a shot in the dark when it can be a calculated step toward a thriving venture instead.
Set yourself up for success in the new year
Making these small, manageable changes to your financial habits now will set the direction for your business to stay on the right course in the new year. As you establish your new habits, you might find that you need financing to meet your business’s financial goals. Pursuit can help! We offer business loans for nearly any need from $5,000 to $5.5 million. Get in touch with us today to learn how we can work together!