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You may not be very organized with your financial records at the start of your business or part-time job. Less than half of small business owners keep track of their cash flow, and 65% of entrepreneurs who fail say they mishandled their finances.
Mismanagement may be due to the fact that all income and expenses go in and out of your personal account. Or both personal expenses and business expenses come and go from the same bank account. Because of this, you may not know what your income is or what expenses are due in the next few months.
The situation is similar among the self-employed (freelancers, people working in the field of side jobs), who “as a rule, do not engage in financial practices that improve their financial situation in the long term.”
This is a big mistake. What gets measured gets better. Likewise, what is not measured is not improved.
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Accurate financial information drives business growth
As a business owner, you need accurate financial information about sales, cash flow, and expenses to properly plan and grow your business. When you know the revenue and profit margin of each product or service, you can decide which products to focus on and which to discard.
You can plan for business growth and sales growth with a marketing and advertising plan. On the other hand, when you don’t know the details of your sales, income, and expenses, you just walk around every day without being able to do long-term financial planning.
The second reason why it is vital to keep financial records has to do with financing a business. Whether you are about to sell your company, attract investors, or apply for a business loan, you must provide accurate financial statements and future business plans. Investors, lenders, and buyers want to see this information in order to decide if it’s smart to invest in your business.
For example, if your business’s sales have grown 15 percent per year over the past three years, you can plan sales and profits for the next five years based on past financial data. This information, known as the Forecast Financial Statements or Provisional Financial Statements, may be of interest to investors. It also shows that you are organized and serious about business success.
A profitable business is more likely to receive external funding through investments or debt financing. A profitable and growing business also has the potential to attract a buyer, which is the goal of many business owners. Wouldn’t you like to be able to sell your business and start something new or invest in passive income streams?
Related: 8 Practical Tips for Launching Your Startup Successfully
Gross profit is a critical figure for a new business
Many startups are unprofitable in the initial stages or break even. You may think that this is bad, but if your business has stable sales and is growing, this is a positive sign, despite the net loss. For this reason, gross margin is the most important metric for a new business.
Gross profit is shown in the income statement and is calculated as follows:
Net sales minus the cost of goods divided by the number of services sold = gross margin.
Gross profit is the number before operating expenses (rent, bills, payroll, etc.) are deducted from income.
As an example, let’s say you own a jewelry store and your selling price per piece is $20, the cost to purchase or manufacture each piece of jewelry is $9, and you sell 750 pieces per month.
Your total net sales is 750 X $20 = $15,000;
Your cost of goods sold is 750 X $9 = $6750;
And your gross profit is $15,000 – $6,750 = $8,250.
When this number is positive and rising from month to month, investors take it as a good sign that the business has potential.
Related: Understanding the difference between gross margin and markup
Your operating expenses such as warehouse rent, payroll, bills, and office supplies could be $8,000, bringing your pre-tax income to just $250, or you could break even. However, as long as your gross margin is positive and growing, this is a good sign.
When you keep accurate records and create financial reports, you can look at the numbers and make important business decisions.
You can create plans to increase sales through advertising. You can plan to keep operating costs stable or cut costs. You can reduce the cost of selling items by buying in bulk or by going to another supplier who sells the same quality material at a lower price. You may decide to hire an assistant and double your sales if the demand is high. You can create your own product instead of buying it elsewhere.
When you understand your numbers and can look at them at a glance and analyze trends over time, your mind can create the right growth strategy for your business. In addition, you can present information to potential investors and obtain much-needed funding. On the other hand, when you don’t know your income, sales, gross margin, or net income, you can’t plan for growth or get investor interest.
So, to be able to grow and expand your business, make sure you keep accurate business financial records and review them regularly.
Related: 5 must-haves for entrepreneurs and their startups to be successful