Managing Finances
There are four critical pieces to managing your finances:
- Understanding Your Financial Statements
- Understanding Your Margins
- Managing Cash Flow
- Using Your “Hired Guns”
Understanding Your Financial Statements
This chapter assumes that you have been in business for a while. Being able to read and understand financials is essential for success in business.
If you do not understand financial statements and how they fit together, talk to your accountant. Here is a quick primer:
Chart of Accounts
Your chart of accounts is a list of the accounts in your accounting system. Each account has a place on either the balance sheet or the income statement.
Balance Sheet
Your balance sheet tells you what you have (assets), what you owe (liabilities), and what your company is worth (equity).
Total assets = total liabilities + equity.
Income Statement
Your income statement (also called the profit and loss statement) shows your revenue minus your operating expenses which equals your net profit. The net profit is how the income statement ties back to the balance sheet. Net income appears on the balance sheet in the equity section.
Using numbers from the income statement and the balance sheet, you can determine the health of your company.
Understanding Your Margins
The biggest mistake I see independent consultants make is in not understanding the margin between the cost of the service, what it costs you to do business (including paying yourself). The margin is what is left over.
For example, let’s assume that you had $100,000 in revenue. You pay yourself $75,000. Your expenses ran about $20,000. Your expenses consist of equipment and software, stationary, business cards, part time administrative help, professional organization dues, accountant and attorney fees, telephone, website development—in short, whatever it took to run your business. This leaves you with $5,000 profit or a 5% margin. This is not a lot of money when you are thinking of hiring someone to help with the work or if you are going to reduce your billable time so that you can write a book.
When you begin hiring people, look at the margin on each individual employee/subcontractor. In other words, the hourly bill rate minus what you’re paying that person (including your share of FICA, insurance, and a percentage of your administrative costs).
When entrepreneurs get started, there is a tendency to pay employees too much and charge customers too little. To help yourself charge the amount you need to cover your expenses and make a profit, make a chart. How this chart takes form depends on your expenses and what profit you want to make.
To increase your margins, you must either increase your revenue or reduce your expenses or both.
Managing Cash Flow
Cash flow is the heart of your business. I do not use the “heart” metaphor lightly. Cash is to your business what blood is to your body. If it isn’t flowing, you die.
In addition to formulating a budget, go through the effort of projecting when money comes in and when your bills need to be paid. If you add people to your staff or if you need additional software or equipment, your cash flow position tells you when is the best time to buy.
Get into the habit of invoicing your clients on a regular basis. If you put off this chore, the payments from your customers will be later than you expected.
Pay your bills on a regular basis. This not only keeps your credit rating good, it also keeps you from getting that false sense of having more money than you can spend.
Using Your Hired Guns
Invest in professional help There are four “people” who are key to your financial health, all of whom are worth their weight in gold.
- Your Accountant
- If you hate the numbers side of your business, it’s worth it to let your accountant manage your company’s finances. You must never abdicate responsibility for your financial health.
- Even if you love doing your own accounting and taxes, when you are spending time doing your accounting and taxes, you’re working IN your business, not ON your business. For more information about this concept, read “The E-Myth Revisited” by Michael Gerber.
- Your Lawyer
- Even if you think you can write your own contracts, DON’T. It is your lawyer’s job to keep up with current contract law. You want to be able to use your own contract on projects. Ask your lawyer to develop a standard contract for you to use. Your lawyer will write your contract with you in mind. If you use someone else’s contract, that contract has been written with that other person in mind.
- Your Financial Advisor
- Your financial advisor will help you determine how much to put away for the future and where to put it. It is your advisor’s job to stay current on financial instruments that will maximize your return.
- Your Payroll/HR Service Company
- If you are doing payroll every other Saturday, you are taking time away from yourself, your family, and your business. There are many payroll services out there that offer group benefits and other HR services, as well as taking care of payroll reporting and doing direct deposit for your employees. Many of them will work with you even if you only have you and one other person in your business.