Business finance is a broad term that is used in many contexts. So, it can be confusing for small business owners. In general, business finance or corporate finance refers to financial management processes. It includes acquiring, allocating, and utilizing funds within the business. When you hear terms like budgeting, forecasting, or cash flow management, know that this is all something that relates to business finance definition. In many cases, however, businesses use the term business finance for the process of securing funding.
Managing small business finances
In the world of small businesses, proper financial management plays a crucial role in long-term success. Effectively managing business finances is not only essential for day-to-day operations. It is vital for long-term planning and strategic decision-making over investment opportunities and cost allocation.
So, what are the main pillars of business finance, and what should a small business owner be aware of?
Financial planning is a good way to start when it comes to business finance. Creating a budget and making forecasts help determine the financing needs of your small business.
Many small business owners make intuitive decisions regarding financial issues. Making financial decisions with a budget to control your costs helps your efficiency. Budgeting is essential as it allows small businesses to create a financial plan for one year ahead.
The value of estimating revenues and expenses and determining how resources should be allocated can not be underestimated. It can help you to make better decisions while working within a tight budget.
If you have a clear picture of the financial requirements of your small business, the next step is to identify suitable funding sources and strategies.
Funding options for small businesses
Small business owners have various funding options available to them, each with its advantages and considerations. It is essential to understand your business’ current and future financial needs. Exploring alternative financing options will help to find the most suitable financing option.
The decision to choose which funding strategy to follow depends on various factors. In general, there are two types of methods when it comes to business financing.
Debt financing refers to acquiring money for your business from external sources. This means your business receives cash from an outside source and promises to repay the principal plus interest.
The most typical source of debt financing is traditional bank loans. There are other options for debt financing apart from bank loans. For example, in the U.S., Small Business Administration offers so-called SBA loans with lower interest rates and longer terms. This business loan can also be a good option for debt finance.
If you do not prefer to obtain a business loan, you can use other forms of debt financing like merchant cash advances, lines of credit, or business credit cards.
Equity financing is when you sell equity in your business to investors in exchange for capital. So, the investors become shareholders and will have proportional ownership in the company. It means they will be entitled to profit and have decision-making power based on their equity portion.
There is a wide range of variety in terms of equity financing. The most relevant ones for small businesses or early-stage startups are angel investors, venture capitalists, and crowdfunding.
Although you sell equity in every case of equity financing, there are significant differences between choosing angel investors, venture capitalists, or crowdfunding. The investment size you need, the involvement of the investor in your business, and the investor’s risk appetite are all relevant factors when deciding what type of equity financing is the most suitable for you.
And the hard part only comes after this. Finding an investor due to the trends in 2023 is challenging. Crunchbase data highlighted that seed and angel investment to U.S. startups fell 45% year over year in the first quarter of 2023 to $3.1 billion. Seed and angel investments in the U.S. are facing their lowest quarterly level since the fourth quarter of 2020.
Cash flow management
Cash flow management is vital for all businesses, irrespectively the size or industry. When it comes to small businesses, the number one reason why many of them fail is because they run out of cash.
Profitability is important for any business, but cash is king when it comes to survival. While a lack of profitability can eventually lead to the closure of a business over time, the lack of cash can quickly force you to close the business.
By effectively managing cash inflows and outflows, businesses can ensure they have enough liquidity to cover expenses like payroll, operational costs, and debt payments. Creating a cash flow statement and forecast is the first step to having an effective cash flow process. Although it will not solve your cash flow problem, it helps to identify the pain points of your cash flow management.
However, estimating your cash inflows and outflow when launching your business is challenging. Creating a cash buffer and maintaining a separate bank account for your business to operate smoothly in your first months is essential. Later, if there are still cash flow problems, you can focus on eliminating unnecessary expenses, growing your revenue, and having a faster process for your account receivable.
Financial decision making
Data-driven financial decision-making helps small businesses to allocate their limited resources effectively. Financial decision-making relies on other parts of business finance, such as financial forecasting, planning, and cash flow management. It is key to running a successful company for the long term to have a well-laid-out financial plan before making crucial financial decisions.
Using forecasts, estimations, and documents like cash flow statements, balance sheets, and profit and loss statements can help to make financially sound decisions.
Financial performance evaluation
The financial performance evaluation provides insights into your business’ financial health and stability. This is important for your everyday business operation and long-term strategic decisions. Assessing key financial indicators related to growth, profitability, and liquidity can help to identify your small business’ strengths and weaknesses.
When acquiring funding from investors, the key financial indicators have a massive impact on your business’ fair market value. Although each financial indicator is important, there are usually one or two key metrics that can significantly affect your business value. Deciding which one is the most important for you can be a complex task. It can depend on your industry, the stage of your business, the funding of your business, and your long-term goals.
For example, if you are a fast-growing startup in the early stage, the Customer Acquisition Cost (CAC) and Cash Burning Rate are some of the most crucial metrics. If you are a mature company, indicators relating to profitability and efficiency are more critical than CAC. Do not get me wrong, CAC is still a relevant indicator for mature businesses. However, companies at the later stages regularly focus on profitability rather than growing fast.
Tax and compliance
Taxes and compliance can be burdensome when you start or plan to start your small business. Setting up effective processes early can help your small business comply with legal, tax, and financial rules. Dealing with tax and legal issues retroactively requires much effort and money and can be complex early. Failing to fulfill financial obligations can result in penalties, fines, or legal consequences.
If your business operates across multiple countries, paying particular attention to your compliance processes is crucial. Every country has different demands in terms of tax compliance. Before launching a product or service in a country, ensure you know your small business’ relevant direct and indirect tax implications.
A solid understanding of country tax rules has a lot of positive impact on your business. Your small business can minimize the risk of audits or investigations by having proper compliance processes to maintain accurate records and meet tax deadlines. Also, comprehending taxes helps make financially sound decisions regarding investment, expenses, and pricing strategies.
It is essential to maintain accurate records and meet tax deadlines. This makes a big difference over time, as your businesses can avoid costly errors and minimize the risk of audits or investigations. Sometimes, when you are unaware of these requirements, it can even force you to change your business model. This eventually changes your pricing, processes, and product or service.