Financial Literacy: What to Know Before You Start Up

by Thom Tracy

2 min read

As a new small business owner, you’re responsible for every aspect of your enterprise. This includes the financial side of your business, which includes everything from accounting to taxes to payroll. For many people, this part of running a business isn’t intuitive, so it can be a tough going once you’re up and running. Errors in managing your company’s finances can be costly and may result in potentially irreversible damage to your company’s reputation.

If you own a new small business, this is the perfect time to improve on your financial literacy, and ensure you have a grasp of critical financial concepts.

Understand the Three Major Financial Statements

The three primary financial statements — the balance sheet, the income statement, and the cash flow statement — each detail a different aspect of your business. Combined, these statements tell the entire story of your business’s financial health, making it vital to understand what these statements are telling you.

  • The balance sheet lays out what your business has (assets), what it owes (liabilities), and what is left over (owner’s equity). It will help show if your current liquidity is able to cover liabilities, such as debt payments, wages, and taxes.
  • The income statement reports the total revenue your business generates against the cost of producing goods and services and other operating expenses to determine net income.
  • The cash flow statement describes how your company’s cash is being spent broken down into operating, investing, and financing activities.

Understand the Importance of Permanent Business Assets

Permanent accounts are those that carry over from one reporting period to the next, and are critical to the health of your business. Examples of permanent assets include cash, receivables, inventories, and prepaid items.

Permanent current assets are essentially what is required to keep your business up and running. Your business needs to maintain at least enough cash and short-term receivables on hand at all times to cover any liabilities you expect to encounter over the next 12 months. As long as you keep your ratio of current assets to current liabilities (also known as the working ratio) above one, you should be able to keep your business running.

Understand Basic Accounting Terms and Equations

Accounting is a dense and complex subject, so it’s understandable that it’s not a specialty of most business owners. However, it is one of the most important aspects of a business, and you’ll need at least a basic understanding to be successful.

These are a half dozen of the most important financial equations you should be aware of. All are high level numbers and ratios that should give you quick insight into how well your business is doing.

  • Owner’s Equity = Total Assets – Total Liabilities
  • Net Income = Revenues – Expenses
  • Working Ratio = Current Assets / Current Liabilities
  • Profit Margin = Net Income / Revenue
  • Debt-to-Equity Ratio = Total Liabilities / Total Equity

References & Resources

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