While it may feel early, many small businesses start to assess their budgets for next year in October and November. As we approach these months, small business owners will likely have discussions on how to become more financially stable — whether that's increasing sales, cutting down on operational costs or investing in new places.
However, at Better Business Bureau Northwest + Pacific, we realize not every business owner knows how to balance a budget.
It's important for owners and leadership in any organization to have a sense of the financial picture, no matter how involved they are in making the calls, because 50 percent of small businesses fail within the first five years and 29 percent of those failures are due to lack of cashflow.
Planning ahead can help ease some of the financial stress many businesses face.
Here's what BBB recommends:
Pay attention to every dime: As a small business owner, it's common to push bookkeeping until the end of every month, or maybe even the end of every quarter. But to really understand your financials, it is important to track every dollar spent.
Plan for sales volatility: After your first year, you should have an understanding what your best months are going to be so that you can prepare cash to cover expenses during the slower months.
Overestimate expenses: Most expenses vary — utilities, overtime pay and supplies, for example. If you overestimate what these costs will be, you'll protect yourself from running dry when expenses are high. If you do end up with extra cash, consider reinvesting it.
Share your budget with employees: Being transparent with employees can help them understand the business, the bottom line and what they can do to help drive the organization toward success.
Put money away for taxes and emergencies: Remember, with profits, come taxes. A good business practice is to set aside at least 30 percent of your profits to take care of tax-related expenses or unforeseen emergencies.
Anticipate future expenses: It's hard to plan for every scenario, but try to consider what's coming down the pike every year. Things like training and recruiting expenses, marketing and advertising costs or making the switch to cloud storage can be upcoming expenses.
Now, let's address one more important item when we're talking about a businesses' financial health: working capital.
Working capital is defined by this formula: current assets minus current liabilities equals working capital. This metric tells investors important information about your operational efficiency and whether the short-term financial outlook is positive. This is a number you'll want to have on hand.
Take it a step further with this formula: current assets divided by current liabilities equals current ratio. When you divide assets by liabilities, this tells investors whether the business has short-term assets to pay off short-term debt. Ideally, that current ratio should fall between 1.2 and 2.
When your current assets are less than current liabilities, you might have a hard time getting capital loans because this indicates you could have an issue paying creditors. This is usually seen as a risky investment.
It all comes down to one important concept: keeping your working capital at a healthy level to predict short-term assets and liabilities, especially available cash.
Why? This is especially applicable for small business owners who might be looking to start a new project or venture in 2020, as this often requires you to dip into your working capital.
Here are BBB's tips on how to improve working capital:
Incentivize receivables: Simply put, this means rewarding customers who pay early or on time and severing ties with customers who default on payments.
Pay your debt obligations on time: Instruct your accounts payable department and/or accounting team to pay debt on time so you avoid additional penalties.
Research vendors: You want to negotiate with vendors for discounts and maintain solid relationships with them so that if you ever need leniency when paying, they'll oblige.
Optimize fixed and variable costs: Reduce these costs wherever possible to try and eliminate wasteful spending. A reduction in expenses has an immediate positive impact on liquidity.
Examine interest payments: Review these terms regularly because, often, the interest on loans and other fixed debt may be eligible for modification. If so, you can pay off the debt faster and save on interest expenses, which again, reduces your liability.
Manage inventory: Don't overstock your inventory and be ruthless about cutting products and services that aren't selling to keep your sales healthy.
Danielle Kane is the Portland marketplace manager for Better Business Bureau Northwest
You count on us to stay informed and we depend on you to fund our efforts. Quality local journalism takes time and money. Please support us to protect the future of community journalism.