Financial literacy is a critical skill for any business owner, helping them be more informed to make strategic moves that benefit the company.

When it comes to running a successful enterprise, it’s essential to have at least some familiarity with every aspect of your organization, from marketing to sales to customer service. But perhaps one of the most vital areas to get to know is your finances. Whether you’re new to owning a business or want to be more in tune with its financials, having a basic understanding of your business’s financial health can empower you to make better decisions, navigate challenges, and ultimately bring in a greater profit.

 Why it’s important 

Financial literacy is crucial for entrepreneurs since it equips them with the knowledge and skills needed to make informed financial decisions that directly impact the success and sustainability of their businesses. With a basic grasp of fundamental financial principles like budgeting, cash-flow management, credit, investment strategies, and financial analysis, you may be able to help your team allocate resources efficiently, minimize risks, and capitalize on future growth opportunities. For instance, if you notice a department is losing money on a current project, looking at its budget can help you understand how funds are currently being allocated and what you can do to reprioritize spending to more lucrative endeavors, thus improving your bottom line.

The basics

Though your business’s finances involve many elements, there are a few foundational ones you should pay particular attention to. Focus on growing your knowledge in these four core areas, and you may be better equipped to handle any financial challenges your business might face in the future.

Financial statements
These are the storytellers of your business, painting a clear picture of your financial health through three key documents: an income statement, balance sheet, and cash flow statement. The first, also known as a profit-and-loss statement, itemizes your total revenue, expenses, and profit over a specific time frame, such as a quarter, to give a broad overview of how your business is doing. A balance sheet, meanwhile, shows your assets, liabilities, equity, and other income not included in the income statement, offering a review of how much you have versus how much you owe. Lastly, a cash flow statement details your business’s cash inflow and outflow, typically over the last twelve months of operations, so you can see where you generate money and where you spend it.

Understanding how to read these statements can help you track profitability, allowing you to better identify if your business is bringing in enough revenue to pay your bills, invest in growth, and cover operational expenses and still turn a profit. Even more, this knowledge will give you a solid base that will enable you to make informed decisions for just about every other financial area of your company.

Budgeting
No business can expect to thrive without establishing and following a budget. Budgeting helps allocate your funds to plan for the future and track your expenses to prevent overspending. So if your company doesn’t currently have one or it isn’t overly comprehensive, that’s a huge red flag. Take some time to review your current financials to understand the status of your fiscal health and where you may need to adjust. What your budget looks like will vary based on your organization’s size and type, but, generally speaking, it should have an itemized breakdown of all your income and expenses. Once it’s set, make sure to sit down and examine it every month or quarter to get a better idea of how well you’re sticking to it and what may need to be changed.

Business credit
As with individuals, having good credit gives your business more favorable opportunities should you need to borrow money to expand your operations. Your credit score gives lenders an indication of your risk factor, or your expected ability to pay back a loan; this can, in turn, impact your loan limit, duration, and interest rate. Numerous factors may impact your credit, such as your payment history, the size and age of your business, and your credit utilization. While personal credit ranges from 300 to 850 (with a good minimum score of 690), business credit scores vary according to the reporting agency. For instance, a PAYDEX score falls between 0 and 100, and you ideally want a score of 80 or above. Generally speaking, the higher the score, the less risk you pose.

Taxes
You may not be the one filing taxes for your organization, but you should still have a general idea of the different taxes you pay and their impact on your organization. According to the IRS, there are five main taxes your company may have each year: income, estimated, self-employment, employment, and excise. The type of business you run, such as a partnership or a sole proprietorship, will determine what you pay and how much. Your business may also be able to claim a number of deductions and credits that can help offset the annual costs, but there are various rules and timelines for each. To avoid ending up in hot water, you may want to work with a tax professional throughout the year to help you better navigate the many nuances of business taxes.

Financial literacy can empower you to take control of your business and make decisions with more confidence. With a foundational understanding of its financial health, you can better prepare yourself to navigate future challenges and position your organization for growth and longterm success.

TAKE ACTION:
Work to improve your financial literacy by examining your organization’s basic financials, enrolling in an educational course, and/or consulting with a financial professional.