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You might not be very organized with your financial records during the beginning stage of your business or side hustle. Less than half of small business owners monitor cash flow, and 65 percent of entrepreneurs who fail say they mismanaged their finances.
The mismanagement may be because 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 might not know what your revenue is or what expenses are due in the next few months.
The situation is similar among self-employed individuals (freelancers, people in the side gig industry), who “tend to not be engaged in financial practices that improve their long-term financial health.”
This is a big mistake. What gets measured gets improved. Likewise, what doesn’t get measured doesn’t improve.
Related: Is Your Startup Failure Holding You Back?
Accurate financial information leads to business growth
As a business owner, you need accurate financial information about sales, cash flows and expenses for correct business planning and development. When you know each product’s or service’s revenues and profit margins, you can decide which products to focus on and which to let go of.
You can plan business growth and sales increases with a marketing and advertising plan. On the other hand, when you don’t know the details of your sales, income and expenses information, you are simply going about each day unable to do long-term financial planning.
A second reason it is vital to keep financial records is for business funding. Whether you intend to sell your company, get investors onboard or ask for a business loan, you must show accurate financial records and future business plans. Investors, creditors and buyers want to see this information to decide whether it is wise to invest in your business.
For example, if your business sales have been growing by 15 percent yearly for the past three years, you can plan the next five years’ sales and profits from past financial data. This information, known as projected financial statements or Pro-forma financial statements, can win investor interest. It also shows you are organized and serious about your business success.
A profitable business has a greater chance of getting external funding through investment or debt financing. A profitable and growing business also has opportunities for getting a buyer, a goal many business owners have. Wouldn’t you like to have the chance to sell your business and start something new or invest in passive income sources?
Related: 8 Practical Tips for Successfully Launching Your Startup
Gross profit is a critical number for a new business
Many startups are not profitable during their beginning stages, or they break even. You might think that is bad, but if your business has consistent sales and is growing, it is a positive sign, despite the net loss. For this reason, the gross profit is the most critical number for a new business.
The gross profit is found on the income statement and is calculated as follows:
Net Sales minus the Cost of Goods divided by the Services Sold = Gross Profit
Gross profit is the number before operating expenses (rent, bills, salaries, etc.) are deducted from income.
As an example, suppose you are a store owner selling jewelry, and your sales price per piece is $20, the cost of buying or producing each jewelry piece is $9, and you sell 750 pieces per month.
Your total net sales are 750 X $20 = $15,000;
Your cost of goods sold equal 750 X $9 = $6750;
And your gross profit is $15,000 – $6750 = $8250.
When this number is positive and growing month after month, investors regard that as a good sign, showing that the business has potential.
Related: Understanding the Difference between Gross Margin and Markup
Your operating expenses, like warehouse rent, salaries, bills and office supplies, might be $8000, leaving you a before-tax income of only $250, or you might break even. Still, as long as your gross profit is positive and growing, it is a healthy sign.
When you keep accurate records and create financial statements, you can look at the numbers and make essential business decisions.
You might create plans to increase sales through advertising. You might plan to keep operational costs stable or reduce costs. You might reduce the cost of goods sold by buying larger quantities in bulk or getting a different supplier that sells the same quality material for less. You might decide to hire an assistant and double sales if demand is high. You might choose to create your own product instead of buying 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 the information to potential investors and get much-needed funding. On the other hand, when you don’t know your revenue, sales, gross profit or net income, you can’t plan growth or get investor interest.
So, to be able to grow and expand your business, ensure to keep accurate business financial records and analyze them regularly.
Related: 5 Must-Haves for Entrepreneurs and Their Startups to be Successful
