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The Noob Guide to Managing Small Business Finances

Some small business owners are finance and management experts. They have a fancy business degree, experience in the private sector, and a strong literacy in all things related to managing small business finances.

This guide, however, is for the rest of you. The ones with little to no finance experience, who had a passion or a big idea and decided to go for it.

If managing your small business finances has you feeling like a total noob, read on for a quick and easy primer into what you need to know

Business Accounting 101

We’ll start our guide to managing your small business finances with the basics of small business accounting. If you’ve never taken an accounting class, this will provide a basic review of terminology, documents, and accounting software options, as well as tips on when and how to bring in a professional.

Terms to Know

As you dive into the world of small business financial management, there are several buzzwords that will likely come up over and over again. If you don’t know the terminology, everything you read about managing your small business finances will feel like it’s in a totally different language. Let’s begin your adventure into financial literacy with a few basic terms:

Gross Revenue

Also called total revenue, your gross revenue is the sum of all monies you’ve received from customers in exchange for your product or service, before taking any deductions or expenses (such as rent, costs of goods sold, taxes, etc.).

Expenses

In the simplest terms, expenses are everything that keep your gross revenue from going straight into your pocket. Things like rent and payroll, costs of materials for goods sold, taxes, interest on debt, utilities and other operating expenses, and more.

Net Profit

Sometimes called the bottom line, net income, or net earnings—net profit is essentially what is left over after you deduct your expenses from your total revenue. When this is a positive number, it means that your revenue is greater than your expenses, and your business is profitable.

Cash Flow

Beyond basic profitability, having enough cash on hand at a given time can often make or break the success of a small business. Even if your business is profitable, you can run into issues if you don’t have enough cash in the bank to pay your bills at any given time. Your cash flow is the difference between the available cash at the beginning of an accounting period compared with at the end of the period. Cash comes in from sales, loan proceeds, investments and the sale of assets and goes out to pay for operating and direct expenses, principal debt service, and the purchase of assets.

Break Even Point

For the first several months (or even years) of doing business, many small businesses will operate at a loss—meaning their expenses are greater than total revenue. The break even point is production level at which total revenues equals total expenses. This is typically the turning point to profitability—an important milestone in the life of every small business.

Documents You’ll Need

Managing a small business involves a lot of paperwork. You’ll need accounting documents to file your taxes, apply for business financing, and for internal tracking of your revenue, expenses, and profitability. These are the four main accounting documents that every small business owner should regularly maintain:

Balance Sheet

The balance sheet is essentially a snapshot of your business’s financial standing at a given moment. It lists the assets, liabilities, and equity your company holds at a given time and is used to calculate the net worth of your business.

Maintaining a “balanced” balance sheet—one in which total assets (everything your business owns) equals liabilities plus equity—is the foundational tenet of basic bookkeeping.

If you’re not sure how to get started creating a balance sheet for your business, access our free downloadable balance sheet template here.

Income Statement

Sometimes called a profit and loss statement, your income statement summarizes your business revenues and expenses over the course of a year, allowing you to calculate your net profit or loss for that year. Maintaining an accurate income statement is critical to determining the break even point for your new business, as well as measuring profitability over time.

Check out our free downloadable income statement template to begin tracking revenue and expenses for your small business.

Cash Flow Statement

Remember how we discussed earlier that having enough cash on hand to cover expenses can make or break a company’s financial health? In fact, this issue is so important, there is an accounting document dedicated to the tracking of cash flow. Your cash flow statement reflects the inflow of revenue and outflow of expenses resulting from all your business activities during a specific time period—usually a month or a financial quarter. Inflow will come from selling goods and receiving payment on invoices, while outflow comes from things like purchasing inventory, payroll, and paying marketing costs and other overhead expenses.

Need help tracking your company’s cash flow? Check out our free downloadable cash flow template to get started now.

Revenue Forecast

Can you afford to hire a new employee or launch a new marketing campaign? If you were to take on a business loan in the coming months, how much of a monthly payment could you reasonably handle? These questions, and thousands more that you likely ask yourself about your business every day, cannot be answered with any degree of accuracy without a revenue forecast.

A revenue forecast is an educated prediction for the upcoming year about how much money your company will likely bring in, so that you can estimate what you can afford to spend, and what your profit margin will be. The more thoroughly researched and realistic your forecasting is, the easier it will be to stay on budget throughout the year.

Accounting Software

Managing the documents above can quickly get overwhelming if you’re trying to manage your accounts manually. Thankfully, there are several great accounting software options available that will take the guesswork out of your bookkeeping and generate these accounting documents automatically. Using these cloud based software services, you can have all of your most important accounting documents always just a few clicks away, as well as handle invoicing and other bookkeeping needs.

Check out our favorite cloud based accounting options for small business owners to find the program that fits your needs.

Quickbooks Online

QuickBooks Online is simple enough for small business owners to use, but accountants love it, too. You can view the status of your finances at a glance using dashboards, or create customized reports. You can also generate invoices, accept payments, process payroll and import expenses by simply taking pictures of receipts with your phone. QBO syncs with your bank accounts and credit card accounts so data is always up to date. You can also share QBO with your accountant to simplify tax time. Their pricing starts at $12.95 per month.

Freshbooks

FreshBooks started out as an invoicing and expense tracking product but has now expanded to include bank account integration, report creation, payroll processing, and time tracking. This accounting tool targets people who want a very simple accounting software and want free customer support from real people. It also integrates with popular apps for CRM, customer service and more. Their pricing starts at $19.95 per month.

Xero

This fully featured accounting tool also uses dashboards, generates reports, creates invoices, handles payroll and expenses and syncs with your bank account. The biggest differentiator? You can add as many users as you want for free! Xero integrates with a the largest range of add-ons to automate tasks such as time tracking, mobile payments and more. Their pricing start at $9 per month.

Hiring an Accountant

While the right software can do wonders to help you manage your small business finances, there are some areas of small business accounting that are beyond the capacity of the average small business owner. It’s in your best interest to hire a professional accountant to review your books for errors at least annually, help with tax filings, and make recommendations for major financial decisions.

Ask your attorney, banker, or a business for a recommended accountant, or contact the Society of Certified Public Accountants in your state for a referral.

The person you choose should be a Certified Public Accountant (don’t assume every accountant is) and licensed to practice in your state. Ask if you can call a few clients to check references, and make sure you are clear about the individual’s fees for services.

In addition to these basics, building a great accountant-client relationship requires the right personality fit. How accessible will your accountant be to answer questions? What areas of your finances will he or she handle, and what will you keep in house? Limit future confusion by discussing each of these issues before you make a selection.

No matter who you choose as your accounting professional or what responsibilities you decide to hand over, it’s essential that you stay personally involved in your small business finances, and that you have checks and balances in place to avoid theft or fraud. While you may be eager to get as much financial management off your plate as possible, being too hands-off with your small business accounting can make you a target for individuals with unsavory intentions.

Paying Business Taxes

Along with getting your books in order, understanding and fulfilling tax requirements should be a first priority in your business financial management. The consequences for failing to file your state and federal business taxes are severe—as in you could lose your business and even face criminal charges. Though dealing with the IRS can be intimidating, this isn’t something you can ignore.

Here’s what you need to know about paying business taxes:

Your Federal Tax Identification Number

Also known as your Employer Identification Number (EIN for short), this number helps the IRS keep track of your business for tax purposes. Think of it like a Social Security number for your business.

While not all businesses need an Employer Identification Number, there are some circumstance where you may need to file for an EIN even if you don’t retain employees—especially if your business is established as a corporation or partnership. Read here to determine whether your business needs an EIN.

If you haven’t yet obtained your Employer Identification Number, you can obtain one immediately by applying online at the IRS website.

Types of Federal Business Taxes

There are four general types of taxes levied by the federal government, and the type of business you run determines what taxes you must pay, when forms and payments are due, and how you’ll file those taxes.

While not every one of these four types of business taxes applies to every business, it’s important to know what they are and understand how they do or don’t impact your small business finances.

Income Tax

All businesses must file annual income tax returns and make payments based on revenue received. The exact tax form you use to make income tax payments depends on the structure of your business: sole proprietorship, partnership, corporation, S corporation, or Limited Liability Company (LLC).

Business income taxes are “pay as you go” taxes, meaning you’ll need to make estimated tax payments quarterly. (See below for additional information about filing estimated taxes.)

Self-Employment Tax

Individuals who work for themselves (including small business owners) must pay Social Security and Medicare taxes via a self-employment tax. This tax is similar to the taxes withheld from the pay of most wage earners.

Estimated Tax

Income and self-employment taxes both qualify as “pay as you go” taxes. You’ll need to file quarterly documents estimating the taxes you owe and make payments accordingly. Click here for forms and more information about how to make quarterly estimated tax payments.

Employment Taxes

If you have employees working for your business, you will have additional tax obligations related to those employees, including Social Security and Medicare taxes, federal income tax withholdings, and the federal unemployment tax. Click here for specific IRS information about filing employment taxes for your business.

Excise Tax

Depending upon what type of business you run, what products you sell, and the types of equipment you use, you may or may not be required to pay excise taxes for your business. Excise taxes most often apply to businesses with heavy fuel usage, but can also apply to such businesses as indoor tanning salons, manufacturers of archery equipment, and many more. Click here to determine whether you’ll need to file a Federal Excise Tax Return for your business.

Your State Tax Obligations

In addition to federal business taxes, most U.S. states and territories will require you to pay income and employment taxes for your business. Certain states have additional fiscal requirements, such as state mandated workers’ compensation and unemployment insurance.

Registration, requirements, and filing procedures vary widely from state to state, so click here to access business tax information specific to where you live.

How Credit Ratings Affect Your Business

Whether it’s a property or equipment lease, a business credit card, or a small business loan, it’s likely that at some point over the life of your business you’ll need access to some form of credit. Your ability to qualify for business credit of any kind will be dependent upon your personal and business credit rating and history.

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Here’s what you need to know about maintaining solid personal and business credit to maximize future borrowing options for your small business.

The Impact of Your Personal Credit Score

As the business owner, your personal credit history can have a big impact on your business’ s ability to qualify for credit. Even if your business has great credit, lenders will look into your personal credit as a measure of your ability to pay back a business loan. It’s important to ensure that your personal credit rating is the best it can be.

At Fundera, we generally advise that a score over 700 is excellent and will offer the best options for those looking for business loans. A score of 650-699 is great. 600 or above is average, and will still give you some options to choose from. In general, we consider a credit score below 550 to be a poor rating with little if any business loan options available.

If your personal credit rating could use some improvement, start by monitoring your credit reports regularly for any discrepancies or irregularities in the reporting. Make sure that you recognize all of the accounts and entries, and if you find an error, contact the reporting agency in writing to correct it. A word of warning—the process is often difficult. But protecting your business’s future financing options is worth the hassle.

Beyond correcting errors, there are a few other “hacks” that may offer a quick boost to your credit score, such as increasing your credit limit (without increasing your spending) or addressing dormant accounts that may be hurting your rating. But overall, the best thing you can do to maintain a great personal credit score is to make all debt payments on time, every time—both in your business and for your personal finances.

How Your Business Credit Score Works

Once you’ve established an Employer Identification Number (EIN), your small business will have its own trackable credit report and history. In addition to your personal credit, your business credit score will be an important factor in determining your eligibility for future business financing.

Your credit score is determined through five main factors—your payment history, amounts owed, your length of credit history, types of credit used, and your new credit. Again, payment history is the most significant of these factors at 35%, so it’s critical that you always make debt payments on time, both personally and for your business.

Dun & Bradstreet is the leading resource to monitor your business credit rating, which you should do at least every six months if you plan to apply for financing in the future. If you encounter an error, contact the agency in writing for a correction.

Small Business Loans

At some point in the financial trajectory of your business, you may need to seek financing in the form of small business loan, either to deal with short-term cash flow challenges, or to fund the growth of your business.

Get acquainted with your borrowing options with this beginner’s guide to small business loans.

Banks vs. Alternative Lenders

Brick and mortar community banks used to be the only game in town for small business borrowing. But in the wake of the 2007 financial crisis, more and more small businesses have been unable to qualify for funding through traditional banks. This challenge, along with over-regulation by traditional banks, gave way to a boom in online alternative lending to fill the gap in availability of small business funding.

That’s not to say you can’t still secure a loan through a traditional bank. If your business has been operating for awhile and you have a solid credit rating, a traditional bank may be able to offer you great terms. But if your credit is less than stellar or you’ve been turned down by your local bank, now there are other options available.

While traditional banks tend to have pretty stringent and specific terms for what loans they will and won’t approve, many alternative lenders are willing to consider a wider variety of factors in making loan approval decisions.

The U.S. Small Business Administration

The SBA is a great resource for small business owners for everything from writing a business plan, to finding a business mentor, to assistance with securing financing for your small business. However, it’s a common misconception among business borrowers that the SBA itself actually loans funds to businesses.

In reality, the role of the SBA in the SBA loan model is to guarantee a percentage of the loan on behalf of the borrower—meaning if you default on your loan, the SBA promises the lender that it will cover the cost up to a certain amount. But the loans are financed by banks or other lending institutions, not by the Small Business Administration itself.

Types of Small Business Loans

With the growth of the alternative lending market, a wide variety of different kinds of small business lending options have emerged to meet the needs of entrepreneurs. With a variety of costs, payment structures, and application processes, sorting out the various loan options can be confusing.

To get you started, here are a few of the most common loan types sought by small business owners:

Term Loans

A term loan is likely the first thing you think of when you imagine business lending. Term loans offer a set repayment time, set number of monthly payments, and have a fixed or variable interest rate. Depending on your business needs, credit rating, and other factors, there are a wide variety of term loans available to many small business owners, with terms ranging from 1 year to 5 years, and everything in between.

SBA Loans

Because of the risky nature of small business lending, many commercial lenders have in the past been hesitant to lend money to small business owners. As a solution, the Small Business Administration began guaranteeing as much as 80 percent of the loan principal for term loans through participating lending institutions.

While this guarantee may make some lenders more willing to consider applicants who don’t fall within their strict loan criteria, applying for an SBA loan still involves lengthy paperwork, and the process can take several months. If you apply, lenders will review your personal and business credit histories and financial statements, and they may require collateral to secure the loan. Despite the government guarantee, not all small businesses qualify for SBA financing.

The SBA offers a variety of loan programs to suit a variety of different business demographics and needs. If you’re considering an SBA loan for your small business, check out our downloadable cheat sheet to learn about every loan program the SBA offers.

Equipment Financing

If you’re looking for financing specifically to purchase equipment for your small business—including computers, machinery, , and much more—equipment financing may be the right choice for you. Equipment financing works very similarly to a car loan. The amount you can borrow depends on the price and type of equipment you’re borrowing, and because the equipment itself serves as collateral, you likely won’t be asked to put up additional collateral. Equipment financing terms typically work at a fixed interest rate — usually between 8% and 30% — with a fixed term length so your payments will be the same from month to month.

Short-Term Loans

For businesses with relatively small and immediate financing needs, short-term loans can be a lifesaver. These loans work similarly to traditional term loans, but cover amounts in the $2,500 to $250,000 range with terms of between 3 and 18 months. With interest rates as low as 14%, short term loan providers can often get you cash in hand in as few as 2 days, allowing you to make rent, cover payroll, or meet other immediate overhead expenses even when sales are slow and cash is tight.

Collateral + Personal Guarantees

It’s an unfortunate reality that despite hard work and great intentions, many small businesses will not succeed. This truth makes lenders especially wary of approving small business loans, as they have a higher risk of defaulting over other types of loans. To mitigate this risk, many lenders will require small business owners to offer collateral or a personal guarantee in order to be approved for funding.

Collateral refers to a specific asset that is leveraged to guarantee a loan—such as your house or other high value personal property. If you put up your house as collateral and then fail to pay back your small business loan, the lending institution can hire a lawyer, get a judgment in their favor, and repossess that property as repayment for the loan.

By contrast, signing a personal guarantee means that the lending institution can leverage any and all assets you have now and in the future to seek repayment for a defaulted loan—either up to a fixed, pre-determined amount (limited personal guarantee) or for the full amount of the loan and interest owed (unlimited personal guarantee). This may include your life savings, retirement, personal property, your children’s college fund, and in some cases even assets owned in your spouse’s name.

Because the terms are more ambiguous, personal guarantees are generally riskier for borrowers than a standard collateral agreement.

Even if you have full confidence in your small business’s prospects for success, signing a collateral or personal guarantee agreement has serious implications on your financial future. Make sure you understand exactly what you’re signing and that you’re comfortable with the terms.

Affording Your Loan

The available options for funding your business may have you dreaming of possibilities for growth. But before you can move forward, it’s important to determine what your loan costs (with a business loan calculator) and whether or not you can afford it.

Here’s what you need to know in order to analyze the affordability of your potential small business loan.

Managing Payments & Amortization Schedules

Make sure you understand the terms of your loan before you sign, and use a loan amortization schedule calculate ahead of time to determine what your payments will be. Depending on the terms of your loan, you may be expected to make monthly, weekly, or even daily payments on principal and interest. For some loans, your payments will be a fixed amount every period, while others will fluctuate over the life of the loan.

If you’re managing debt from multiple sources—such as a business loan, business credit cards, and lease payments—our downloadable business debt schedule template can help you track payments and make sure that you have the cash on hand to cover all payments as they are due.

Debt Service Coverage Ratio

In a business context, the debt-service coverage ratio (DSCR) is the ratio of cash a business has available for servicing its debt—such as payments on loan principal, interest, and leases. Lenders will use this ratio when reviewing your loan application to determine whether your business can afford the loan you’ve applied for.

To calculate your debt-service coverage ration, first calculate your EBITDA (earnings before interest, taxes, depreciation, and amortization), then divide that number by the sum of your interest and current maturities on long term debt. If you’re looking at applying for a particular loan, factor the terms of the loan into the equation to see how it affects your debt-service coverage ratio. Or try our free debt coverage ratio calculator for a quick look at the numbers.

Typically, lenders look for a ratio of at least 1.25. This demonstrates a cushion so that if you have a slow sales month or an unexpected expense comes up, you’ll still be able to make your loan payment. If you’d like to be more conservative, aim for a loan that leaves you with a DSCR of 1.35 or even 1.5.

Loan Performance Analysis

Even if you can technically afford to make monthly payments on a business loan, that does not mean taking on the loan is a good idea for the financial future of your business.

Using basic information about your loan—including the amount, interest rate, and term—as well as basic revenue information about your business, you can complete a loan performance analysis to estimate when you’ll break even on the cost of the loan, your expected monetary gain, and the approximate profitability of your loan on a five or ten year horizon. If the impact over your preferred time horizon is profitable, then that might be a good reason to take the loan.

To determine whether taking on a small business loan is the right choice for your business, click here to access our free loan performance analysis template.

Business Funding Alternatives

Small business loans aren’t the only way to finance your small business. Here are just a few of the alternatives you might consider to cover the initial costs of your latest business venture:

Capital Investors

Every day, thousands of investors and venture capitalists are contributing both finances and expertise to what they see as the “next big thing.” If your business idea has a high chance of profitability, you may be able to spark the interest of a capital investor.

Friends and Family

If your family and friends seem supportive of your business venture, they may be willing to invest funds to help your business succeed. Of course, accepting funds from friends or family comes with its own set of challenges. Even when everyone has the best of intentions, loss of income from a failed business deal can ruin relationships.

Should you choose to go this route, do everything you can to keep it professional. Offer a well thought out, professional quality investment proposal as you would to any other investor, and set the exact terms of the investment in writing. The more negotiated up front, the less risk you’ll have of dealing with miscommunications or relational challenges with those closest to you down the line.

Crowdfunding

Or maybe you have a network full of acquaintances and contacts willing to contribute to your business venture in smaller amounts. Don’t underestimate the value of a few hundred $50, $20, or even $10 pledges towards your overall fundraising goal. That money adds up fast. And if your campaign goes viral—catching the attention of folks outside your immediate network—the possibilities grow even further.

Platforms like Kickstarter or IndieGoGo are great for smaller ventures looking to offer product or other goodies in exchange for a contribution. Larger scale ventures might consider equity crowdfunding platforms like EquityNet which sell company equity to capital investors in a crowdfunding format.

One Step At a Time

For a rookie entrepreneur with little to no business education, all of this information can be daunting. If you’re overwhelmed, contact SCORE or a Small Business Development Center for information about being paired with a mentor. Working with a veteran entrepreneur one-on-one is a great way to overcome the learning curve associated with managing small business finances.

Above all, remember: the transition from managing your receipts in a shoebox to professional level business financing doesn’t have to happen overnight. Just take things one step at a time, and look for the next thing you can do to get your small business finances in line.

 

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Meredith Wood

Meredith Wood

Editor-in-Chief at Fundera
Meredith is Editor-in-Chief at Fundera. Specializing in financial advice for small business owners, Meredith is a current and past contributor to Yahoo!, Amex OPEN Forum, Fox Business, SCORE, AllBusiness and more.
Meredith Wood