Financial decisions are among the most important decisions that business owners have to make. They affect everything from the company’s financial health to the company’s ability to grow, and they are important for major corporations and small businesses alike.
Over half of small businesses fail within the first five years, and poor financial decision-making can certainly play a part. The businesses that are thriving, on the other hand, are those that are making well-informed financial decisions that put them in a position to succeed.
In this post, we’ll go over some of the best ways to make solid financial business decisions in 2020.
We’ve spoken before on the topic of financial statements. Having a good grasp on these documents is a key element of running a business smoothly.
To quickly recap, the three main types of financial statements are:
Balance sheets: These provide a financial snapshot of your business at a certain time. They illustrate how your company’s assets are funded: through liabilities or equity.
Income Statements: These statements report on revenue over a specific period of time, and are also known as profit and loss statements. They calculate net income by subtracting expenses from revenue.
Cash flow statements: Understanding cash flow is critical to keeping your business in top shape. Cash flow statements report on your company’s inflows and outflows of cash and are a great indicator of your company’s ability to handle debts and fund operations.
How Can I Use Financial Statements to Make Business Decisions?
Financial statements are especially useful when it comes to making sound financial decisions because they provide you with a detailed picture of your company’s financial health. They also make it easier to see how past business decisions have influenced the performance of your business.
In making sound financial decisions, you want as much information as possible. Simply looking at your company’s profit margin just isn’t enough. Understanding important factors like the amount of cash on hand and how your assets are funded will help you or your financial manager make the best decisions possible.
Types of Business Financial Decisions
There are three main types of financial decisions that every company has to make. A strong understanding of each is what will help you make the best moves for your company in 2020.
These decisions are concerned with how your business invests in assets. Determining the right allocation of funds is a crucial decision you or your CFO consultant will have to make.
Investment decisions can be broken down further into two categories: short term and long term. Short-term investment decisions affect the amount of working capital your company has on hand. It’s important to make decisions that don’t jeopardize your company’s ability to pay off unforeseen costs and that allow you to continue operating at peak efficiency. This is also known as working capital management.
A long-term investment is one that can have a broader impact on the future of your company. These types of decisions are usually more permanent and have a lasting effect. This makes proper planning essential.
Making the right investment decisions is important, but so are the methods you use for funding those investments. Financing decisions are concerned with how your company pays for its investments and expenses.
There are two main sources of funds a company can use to make investments, and they each have their advantages and disadvantages. You can use the company’s funds, or you can raise funds externally.
Raising money from external funding primarily happens one of two ways: taking on debt or selling equity in the company. Taking on debt means taking a loan; your company will have to pay back the funds it raises with interest.
While borrowing money can be tax-deductible and therefore a less expensive way to raise money, it’s also associated with a high risk in comparison with selling equity.
Selling equity means selling a portion of your company. When a company “goes public,” public investors are able to purchase stock in the company, which is an exchange of ownership of a small part of the company for money.
The best debt-to-equity ratio will provide your company with optimum capital structure, which maximizes the market value of your company while minimizing the cost of capital. Choosing the right mix of financing options — borrowed funds or sold equity — is crucial in maintaining high market value.
These decisions affect the management of profits earned by a company. The primary methods for managing earnings include distributing it to shareholders and retaining it as profit. There are advantages to both, and the right mix is unique to every situation.
What are dividends?
Stocks that pay dividends are those that periodically pay a small portion of the company’s earnings to the shareholders.
This is attractive for investors looking for quicker returns on investment, but it has its downfalls. Since a portion of earnings is being distributed to shareholders instead of invested back into the company, there’s a chance that the company won’t grow as much as it could; this would lower the eventual return on the investment.
When it comes to dividends, it’s important to consider cash flow. Dividends represent a cash outflow. Therefore, maintaining dividend payments requires having a sufficient amount of cash on hand to pay shareholders.
A budget is directly related to the types of financial decisions we mentioned above. It’s a plan that describes what you will spend money on (investment decisions). In addition, it dictates how you’ll finance the spending (financing decisions).
The Benefits of Budgeting
The benefits of a smart budget are many. It’s how you plan for the future, make sure projects are sufficiently funded, monitor performance, and manage your money effectively.
In addition to these benefits, budgeting is also one of the best ways to manage your cashflow. As we’ve mentioned, this is one of the most important parts of keeping your business healthy and performing well. You’ll need well-managed cash flow to invest in new opportunities at the best possible time.
Budgeting is also a great way to stay organized when it comes to finances. As a business grows, monitoring the movement of funds becomes more difficult. An organized budget can help you stay in control of your expenses — it’s important to know exactly where your company’s money is going.
Creating a Budget
The best budget is a detailed one. In creating a budget for your business, be sure to use as much financial information as is available to you. At the bare minimum, this entails looking at your projected sales for the budget period as well as the costs involved in doing business.
The costs you’ll have to look at mostly fall into two categories: direct costs and fixed costs.
Direct costs are those directly associated with creating your product or providing your service. The materials you need to purchase in order to manufacture your product are a prime example.
There is a wide range of types of fixed costs, but some examples are:
- Employee wages
- Marketing efforts
- Travel expenses
Your budget should break down expenses into these different cost categories, and you may need different budgets for different departments in your business, depending on its size.
Are You Prepared for Emergencies?
One of the first things a profitable business should do is to allocate funds to protect solvency in worst-case scenarios. It can be tempting, especially when a business first starts to really grow, to put all the extra money back into expanding the business further.
Before you invest in more growth, be sure you have enough money put aside to bail the company out of an unfortunate situation. After all, there is no shortage of risks involved in running a business.
Another sound financial decision you can make is to find the right kind of business insurance to help protect your company.
How Much Should You Spend on Marketing?
It can be easy to overlook just how important a marketing budget is, especially when your company is performing well. Marketing is an investment in future revenue, and businesses that don’t plan ahead by allocating sufficient funds to advertisement can fall behind in future quarters.
While the exact number will be different for every situation, consider putting 10%-15% of your revenue towards marketing.
Is Your Business Ready for 2020?
Decision-making is really what being a business owner is all about. Making the right decisions at the right time is what separates underperforming companies from those that excel. The financial decisions made on behalf of your company are some of the most crucial.
What’s the most effective way to make great business financial decisions? To have the most thorough understanding of the business possible. At the very least, this means using your financial statements and monitoring budgets to assess your current financial situation and plan for the future.
Whether you enlist outside help or go it on your own, an informed decision is a good decision. Make the next year as profitable as possible with the right financial decisions for your business.
At Saddock Advisory, we can help determine if your business is financially healthy. Get in touch with us here to find out more.