A new year provides a fresh opportunity to build good habits for your small business. As January approaches and you set the direction for your business for the year ahead, now is the time to adopt some best practices for business financial management. You’ll start the next year on the right course and set yourself up to grow your business.
There are many good habits that your small business can start now to improve its financial health in the year ahead. Get started now to establish goals and evaluate what strategies will help you achieve those goals.
If you need a good place to start setting your goals, use these five steps. you’ll create good habits while implementing best practices going forward.
1. Identify benchmarks for operating performance
To set financial goals for the next year, start by identifying benchmarks for your business. This is a key step in good business financial management. Benchmarks are the key metrics that demonstrate how your business is doing now, and they can be used to compare how your business performs in the future. Some typical benchmarks include:
Gross margin: Gross Profit ÷ Total Sales
This benchmark tells you how effectively your business is turning products and/or services into revenue.
Operating margin: Operating Profit ÷ Total Sales
This benchmark tells you how effectively your business is turning a dollar of sales into a dollar of profit after all tangible expenses.
Once you’ve identified your benchmark metrics, you can assess whether your performance needs improvement based on standards for your industry. You can find this information in IBISWorld market research reports or the Risk Management Association’s annual industry data.
Monitor these benchmarks throughout the year to assess whether you’re getting more or less effective at reaching your goals. Your benchmarks can also help you create financial projections to better guide your business’s growth. If you want a more in-depth method for benchmarking your entire operation, try conducting a horizontal analysis and a vertical analysis.
2. Set goals to improve your profitability
Once your benchmarks are identified, it’s time to work on setting goals to boost your profitability. What causes your business’s profits to increase? It’s pretty straightforward. Either your total revenue increases, or your cost of goods sold (COGS), and/or overhead decreases.
Making these changes happen is the difficult part of business financial management and each has different advantages. Here are a few things you need to consider when planning how to best increase your profitability:
Increasing revenue: Focusing on improving revenue is an important way to grow your profitability. Unlike cutting costs, it’s less likely to compromise other parts of your operations.
Of course, growing your top line can be the most challenging way to increase profitability because it ultimately relies on your gross profit margin. Your gross profit margin measures your business’s efficiency.
If your business has a lower gross profit margin, it will see less bottom-line improvement in profits by growing revenue. If your business has a higher gross profit margin, it will get more of a bottom line improvement in profits by growing revenue.
Try targeting a new market segment with higher pricing to increase your revenue. You could also state offering related products or services that carry higher margins. These are great strategies for driving profitability through increased revenue.
Decreasing Costs of Goods Sold (COGS): Decreasing costs associated with each transaction that your business makes will improve your gross profit margin. This can be the most effective way to increase your profitability in the long term. Just make sure that you’re able to decrease your costs without making unnecessary compromises on the quality of your product or service.
Decreasing overhead: Decreasing operating expenses is a go-to strategy that many business owners try when their financials need improving. It’s the easiest and quickest way to grow profits. Determine where there are opportunities for operational efficiencies in your business and you’ll see a positive impact on your profitability.
3. Plan for major expenses
You know the old adage, “you need to spend money to make money.” It’s true for most businesses, and having a plan for major expenses can help you manage this approach.
Create a list of expenses that will help drive increased sales over time. It can include expenses for equipment and other fixed assets, expansion or relocation of current facilities, and other expenses to grow your business.
Because these expenses tend to be larger, you’ll usually need to find financing for them either through a lender or an investor. The best time to apply for financing is months before you actually need it. Start three to six months in advance of your actual needs to make sure you have everything that’s required for a business loan application. you can get in touch with a lender now to find out what they’ll require so you can start gathering documentation now.
4. Discuss your tax planning strategy with your accountant
Far too many small businesses take an overly aggressive approach to tax savings. Many fall 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 compromise your business’s future in pursuit of 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 business’s reported cash flow available for debt service as a source for repayment. If you’re not reporting revenue and expenses properly, they’ll think you’re not going to be able to repay a 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
Make it your goal for the new year to update your books at least once a month. Having up-to-date information at your fingertips allows you to make better business decisions in real-time.
Reaching this goal starts with you. To have accurate and timely financial information, you may need to hire employees and increase your bandwidth to prepare cash flow statements and income statements. You could hire a bookkeeper who works exclusively for you, or give the task to a team member with experience and knowledge of managing business finances.
If you’re unable to hire a bookkeeper or delegate this task, make time to do it yourself. Either way, you as the business owner should know how to produce internal financial statements and have confidence that these statements accurately demonstrate the key aspects of financial performance.
As a busy entrepreneur, reviewing financial records frequently might seem like a burden, but without accurate financial reports and a sense of ownership of your own business’s financial information, the work you put into selling could just be a shot in the dark rather than a step toward a stable business.
Establish these business financial management best practices to set yourself up for success in the new year
Making these small, manageable changes to your financial habits now will give you the tools to set the direction for your business and stay on the right course as you enter the new year. As you establish your new habits, you might find that you need some financing to meet your business’s financial goals. Pursuit can help. We offer more than 15 different loan programs for nearly any business need. Get in touch with us today to learn how we can work together.