Small Business Finance | 11 mins read

Managing Small Business Finance - Guide for Startups

managing small business finance guide for startups
Chloe Henderson

By Chloe Henderson

Navigating the documentation and financial obligations involved in launching and maintaining a business can be complicated. Owners need to know how to establish separate business credit, differentiate tax laws, and choose the appropriate loan for their business.

Without adequate small business finance management, owners could face the risk of defaulting on loans, going bankrupt, or facing legal repercussions from erroneous tax filing.

Small businesses must take the time to review the best accounting practices and mandatory financial reports before investing time into expansion efforts. By ensuring their finances are in order, these organizations can remain compliant while working on turning a profit.

Separating Business and Personal Finances

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Before jumping into the business's finances, owners must first separate their personal finances. Separating the business and personal finances makes it easier to manage bookkeeping, taxes, and compliance regulations. This ensures that a business won't face legal repercussions due to poor financial management.

When business owners separate their personal finances, they are protected from any legal trouble their future company may face. Therefore, executives should start by setting up a business account-

Open a Business Bank Account

Opening a separate business account is crucial for proper small business finance management. There are many different accounts to choose from, each with their own unique advantages and disadvantages. Business owners should consider several factors, including-

  • Business checking versus a savings account
  • Monthly fees and waives
  • Included transaction services
  • Wiring capabilities
  • Cash deposit restrictions
  • ATM access
  • Online and mobile banking options

All of these components impact how management can interact with the business's account. Therefore, owners must take the time to weigh their options.

Understanding Business Accounting

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Owners must understand the basics of small business accounting, from key terms to mandatory documentation. By learning these essential accounting elements, companies can establish efficient bookkeeping and financial management systems.

Key Accounting Terms

While there are countless accounting terms businesses are bound to come across, there are several that are used frequently, such as-

  • Gross Revenue, also known as total revenue, is the sum of all income a business receives from customers in exchange for products or services before any deductions. These expenses include taxes, overhead costs, labor wages, and any other fees.
  • Expenses include any deductions that reduce the net income, such as rent, payroll, taxes, interest, utilities, and operating costs.
  • Net Profit, also known as the bottom line, net income, or net earnings, is the capital left over from the gross revenue after deductions. When the net profit is positive, revenue is greater than expenses, meaning the business is profitable.
  • Cashflow consists of the activity of available cash a business has on-hand at the beginning and end of an accounting cycle. This cash can originate from loans, investments, assets, and sales and can be put towards operational costs, debt, and purchases.
  • Break-Even Point is the production level where the gross revenue and total expenses are equal, marking the turning point to profitability or operating at a deficit.

Accounting Documents

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Managing a small business's accounting department involves extensive paperwork, from filing taxes to applying for financing. However, there are four primary types of documentation that companies must maintain, including-

1. Balance Sheet

A balance sheet is an outline of a company's financial health at any point in time. This document defines all assets, liabilities, and equity a business has in order to determine their worth. Maintaining a balance sheet at all times is essential for standard bookkeeping.

2. Income Statement

An income statement, also referred to as a profit and loss statement, is a synopsis of a business's revenue and expenses over a fiscal year. This enables management to calculate the net profit, break-even point, and expense reports to measure their overall profitability.

3. Cashflow Statement

A cash flow statement defines the flow of revenue and expenses that enter and exit a business within a specific timeframe, typically over a month or quarter. Inflow will stem from sales and invoice payments, while outflow consists of inventory purchase orders, labor wages, and overhead expenses.

4. Revenue Forecast

A revenue forecast is an estimate of a company's profitability for the following year. This enables management to determine whether they can afford a new hire, need to implement cost reduction strategies, or should launch expansion efforts.

How to Keep Track of Small Business Finances

While some small businesses choose to manually handle finances, it is easy to outgrow manual methods once a company begins to expand. Therefore, executives should consider modern tools and more efficient means of financial bookkeeping, such as-

  • Implementing Management Software
Management software, such as accounting and forecasting solutions, automate repetitive documentation procedures so employees can focus on other tasks. This significantly reduces human error and labor costs while improving operational efficiency and responsiveness.

Management software automatically fills out data-fields with default information, shares documents with the appropriate departments, and monitors existing systems' activities.

For example, forecasting solutions track real-time sales and expenses and reference historical data to predict future outcomes. Businesses can generate forecast reports on demand, sales, and profitability depending on their needs.

  • Hiring an Accountant
While accounting solutions are great for handling standard paperwork and tasks, small businesses with more unique needs should consider hiring an accountant. A professional accountant will review a company's books to correct errors, file taxes, and recommend how to improve financial decision-making.

Businesses can find accountants by asking their bank, attorney, or competitors for a recommendation. Owners can also contact their state's Society of Certified Public Accountants.

Fulfilling Business Tax Responsibilities

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Once accounts are separated and bookkeeping is organized, executives need to learn the appropriate tax requirements. Each company is subject to different tax laws depending on their industry, making it crucial to thoroughly research how to file business taxes. If an organization fails to file correctly, they can face legal repercussions.

To start, small businesses need to-

1. Apply for a Federal Tax Identification Number

Also known as an employer identification number (EIN), the federal tax ID enables the Internal Revenue Service (IRS) to recognize each company on paper.

While not every small business needs to apply for an EIN, owners need to determine whether their business model is required to retain an ID. To determine their eligibility, organizations should refer to the IRS website or speak with a representative.

2. Learn Federal Business Taxes

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Depending on the industry, there are four primary taxes that businesses are subjected to pay the federal government. Different types of companies may need to fill out various forms or meet different deadlines. Therefore, business owners should ensure that they understand-

  • Income Tax
Every company must file an income tax return yearly to make payments on its earned revenue. An income tax return looks different for every business depending on the ownership. The document can cater to a sole proprietorship, partnership, corporation, or limited liability company (LLC).

  • Self-Employment Tax
Self-employment tax applies to individuals who work for themselves and need to pay social security and Medicare taxes.

  • Estimated Tax
Certain taxes, such as income and self-employment, qualify as "pay-as-you-go" taxes where businesses can pay in increments every quarter, rather than a lump sum the following year. Executives need to file documents each quarter that estimate the taxes they owe to begin making payments.

  • Employment Tax
Any company that retains employees must pay an employment tax to pay social security, Medicare, income tax withholdings, and federal unemployment taxes.

  • Excise Tax
The excise tax only applies to businesses that sell specific goods, such as fuel, alcohol, and tobacco.

3. Learn State Tax Obligations

In addition to these taxes, each state has its own set of income and employment taxes. Some states even require businesses to pay additional financial obligations, such as workers' compensation and unemployment insurance.

Businesses can learn about their state's registration and filing procedures through the state's chamber of commerce website.

Improving the Business's Credit Score

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Small businesses should prioritize boosting their credit scores to gain better financial standing when it comes to applying for loans and financial assistance. This is especially important when companies begin expanding and need to have good credit standing to receive financing for more equipment and larger facilities.

By learning how credit scores work and how to promote financial health, businesses can begin establishing a good credit history-

How Business Credit Scores Work

Once a business receives an EIN, owners can begin opening credit lines under the company's identity. A business's credit score reflects how well they manage their debts, meet payment deadlines, and balance all open lines of credit.

When applying for loans, leases, credit cards, and any other acquisitions, the provider checks the company's credit score before determining whether to proceed. A bad rating reflects poor fund management and often leads providers to deny requests, as the business poses a financial risk.

Businesses should monitor their credit ratings every six months to ensure they are in good standing and no erroneous demerits have been charged to their accounts.

How to Boost Personal Credit Scores

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Even if a business has great credit, lenders will look at the owner's personal credit before approving applications. Therefore, business owners must get their personal credit in good standing as well. The higher the personal credit, the better the contract agreements are for loans, leases, and available credit.

Business owners can boost their personal credit scores by-

  • Paying all bills in full and on time
  • Avoiding loan defaults, bankruptcy, collections, and foreclosures
  • Keeping credit spending as low as possible
  • Monitoring credit reports to ensure there are no mistakes
  • Making regular payments on debt

Owners can also boost their ratings by increasing their credit limit while reducing their spending. This creates a smaller credit spending ratio, showing lenders that the business does not need to rely solely on credit.

Discovering Loan and Financing Options

Whether raising funds for a startup or expansion, executives should know their options regarding small business loans. Every lender has its own requirements and ideal credit scores. It is vital to request this information before applying, so management has the chance to align financials to increase the likelihood of approval.

Types of Small Business Loans

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While traditionally, small businesses had to apply for loans at traditional banks, modern companies have access to alternative online lending. These lending options are ideal for startups without an established credit line.

Aside from SBA loans, the loans that are offered by non-traditional lenders include-

  • Term Loans
Term loans abide by a strict repayment time, monthly payments, and either a fixed or variable interest rate. Depending on the company's credit score, a term loan can range from 1-5 years.

  • Equipment Financing
Equipment financing is a much smaller loan for businesses looking to invest in machinery, such as computers and production equipment. This loan works similarly to a car loan, where the equipment serves as collateral, and the loan amount depends on the equipment price. Equipment financing typically uses a fixed interest rate between 8% - 30% at a fixed term length.

  • Short-Term Loans
For companies that need immediate assistance or small financing, short-term loans cover $2,500-$250,000 for between 3-18 months.

With a short-term loan, owners can receive physical cash within one business day, making it incredibly helpful when companies are short on rent, payroll, and other immediate financial obligations.

  • Business Lines of Credit
Aside from a credit card, a business line of credit gives companies a set amount of funds that can be withdrawn at any time. This way, businesses only have to pay back the funds that they used, plus interest.

  • Small Business Administration Loans
Small business administration (SBA) offers a variety of loans to cover different company needs. The SBA has a strict application procedure with extensive paperwork and reviews.

Businesses must provide their credit rating, the owner's personal credit score, and financial statements. Some organizations even need to offer collateral.

How to Prepare for a Loan

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Once a business determines which loan best fits their needs, management needs to organize the finances so they can make regular loan payments. In order to better manage small business finances, executives need to-

1. Manage Payments

Each loan has a different repayment schedule, ranging from daily to monthly payments. Managers also need to consider the interest rate and how it affects the payment amounts. Once all loans and debts are defined, businesses can create a repayment schedule to ensure they make timely deposits.

2. Calculate the Debt Service Coverage Ratio

The debt service coverage ratio (DSCR) compares a business's available cash to its debt. Lenders reference this ratio during the approval process to measure the company's financial stability. Institutions typically look for a ratio of at least 1.25.

Management can calculate their DSCR by dividing their earnings before interest, taxes, depreciation, and amortization (EBITDA) by the sum of their loans' interest. Businesses may need to alter this formula if their loans have additional repayment terms.

3. Complete a Loan Performance Analysis

Conducting a loan performance analysis estimates a company's break-even point regarding loans, the return on investment (ROI), and estimated monetary gain.

Small business financial management includes various documentation and compliance requirements. By reviewing federal regulations, accounting terms, and financial assistance, executives can begin planning their business models.