business finance 101, business finance definition, basics, and best practices

you have a great idea you have a product
or service for which the war has been waiting you've scraped together
enough cash to get your ID off the ground you have a location you've done
your advertising you just know this is going to work and six months later
you're out of business statistics from the Small Business Administration
indicate that about half of new businesses fail in the first five years
many new businesses fail and the reasons are many and varied in this course we're
going to address some of the primary financial reasons that new businesses
don't make it there are of course many non-financial reasons that new
businesses struggle poor marketing poor location poor product quality we're
going to limit this course to the financial reasons for business failure
if you get everything right but the financial side of things your business
is going to struggle of course if you get the financial side of things right
and drop the ball with the non financial aspects of the new business you'll
struggle as well with this course we'll stick with the financial aspects of
struggling new businesses because that's what we know a little something about we
have identified five common reasons that new businesses that struggle seem to
face of course this is not an exhaustive list but these five reasons seem to
consistently pop up when it comes to new businesses that struggle those five
reasons are insufficient capital poor cash management poor record-keeping and
controls improper product pricing and uncontrolled growth before we get
started let me first say that several of these reasons for struggling are
interrelated uncontrolled growth can relate to poor cash management poor cash
management can relate to poor record-keeping and so on while these
topics can be interrelated we will address each one separately and then
comment on the interrelationships when they are apparent so let's get started you let's begin with the money needed to
start a business too many new businesses start their business without enough
capital they just don't have enough money in the bank to support them while
their cash flows get up to speed it turns out that the rent has to be paid
the utilities have to be paid equipment may need to be purchased or rented the
employees have to be paid the inventory has to be purchased all of your expenses
have to be paid but you're waiting for potential customers first to find you
and then second to pay you there's often a lag between when you get paid for
providing a good or service and when you have to pay your vendors and generally
that lag is not in your favor also when starting a business it takes
time for your customers to find you and for you to get your sales and marketing
efforts up to full speed during that time your expenses will continue to need
to be paid it would be nice if all customers would pay immediately it would
also be nice if vendors would wait to be paid until you are paid yeah that would
be nice many businesses are forced to close
before they are able to find out if their business model has a chance to
demonstrate that its sound they just run out of money when starting a business
realize that it will take time for cash inflows to start flowing but the cash
outflow start flowing immediately make sure that you have access to sufficient
capital to allow your new business venture enough time to succeed so how
much cash is enough cash the answer to that question can only come through a
careful budgeting of cash inflows and cash outflows it is critical that is
part of your business plan you sit down and carefully and realistically map out
your expected cash inflows and outflows for at least the first six months of
your new business this exercise will allow you to
determine any forecasted cash shortage and will allow you enough time to
arrange for needed financing either from partners or from creditors knowing well
ahead of time that you will need cash allowed you to make necessary
arrangements for financing finding out today that you need cash tomorrow
puts you in an unnecessary bind we will talk a little later in the course about
the specifics of cash management but it is critical upfront that you have an
understanding that not having enough money to get started can result in a
good idea meeting and early demise make sure you have sufficient capital or
access to sufficient capital before you open the doors to your new business
again many new businesses with great business ideas don't make it through the
critical first few months a great ideas not sufficient you need to ensure that
you have access to enough capital to get you through those first few months by
the way if you plan on going to a bank to ask for financing for your new
business one of the first things they will ask about is your cash forecast
they will want to know what capital you currently have available to you if you
plan on asking friends and family to invest if they are smart they will ask
about your cash forecast to obtain capital from others you need a cash
forecast you might as well prepare one for yourself the cash forecast will
allow you to determine how much capital you will need to get you through those
critical first few months you we know you'll need sufficient capital
get your new business through the critical first few months let's assume
you've made it through those first few months you will still need to track your
cash inflows and outflows to ensure that you have sufficient cash to pay the
bills that are surely coming whether you are at the start of your business or
well into the lifecycle of your business managing cash is critical for the
well-being of your business and cash management does not happen by chance it
is up to you to ensure that your cash is managed we will do this by preparing a
cash forecast or budget let's start our discussion of cash management by
distinguishing between two types of costs fixed costs and variable costs
fixed costs are exactly that they're fixed budgeting for fixed costs is
relatively straightforward the amount is fixed at least over the short-term
variable costs are costs that vary relative to some activity or cost driver
for a restaurant for example costs might vary based on the number of customers
first shop at the mall costs may vary based on the number of hours that the
shop is opened labor costs utility costs and so forth now there can be a number
of cost drivers or in other words costs can vary for a number of reasons it just
depends on how complicated you want to get adding more drivers makes the
arithmetic a little more complex but the concept is still the same now step one
in cash management is to identify all of your fixed and all of your variable
costs all of those costs it's easy to forget an expense here or an expense
there and before you know it your cash forecasts are useless the cash forecast
is only as good as the inputs next we'll talk about variable costs answering the question how many
customers can we expect is the hard part please don't gloss over this question
your business will fail or succeed based on the answer to this question how many
customers can you realistically expect many costs will vary based on
anticipated customer demand answering this big question is beyond the scope of
this video but it would involve such things as scoping out your competitors
volume of business assessing expected population growth in
your area surveying potential customers a whole host of things your forecast of
sales will be critical in helping to prepare your forecast of cash inflows
and outflows we will do some sensitivity analysis with these numbers to determine
what might happen to our profits if more or fewer customers show up now that we
have a reliable forecast of our cost driver at least as reliable as possible
we can now compute our variable costs please note that as our business grows
and matures we will be able to determine a much more reliable estimate on the
number of customers we can expect let's now turn our attention to the next
area where new business owners tend to drop the ball that is the area of poor
record-keeping most new business owners hate to worry about the record-keeping
they would rather worry about customers and sales and evasion and growth and
everything other than record-keeping proper record-keeping and internal
controls are the blocking and tackling of new businesses not very glamorous and
not very interesting but it needs to be done and it's safe to say that it needs
to be done well you can liken proper record-keeping and adequate internal
controls to the keeping of statistics in a football game the person tracking the
statistics is not on the field playing the game but those statistics are very
helpful to those who are on the field playing the game as we discussed in the
previous video on cash management you need to track your inflows and outflows
of cash so that you can forecast future cash flows all we're talking about here
is developing a system of tracking your inflows and outflows your obligations to
others and others obligations to you it can be as simple as that depending on
the size of your business you can purchase accounting software
off-the-shelf there are a number of great products that will do the job with
minimal training but it is critical that someone take responsibility for keeping
the books why is it critical well three reasons off the top of my head first
more accurate information about your business will assist you in running your
business better you will need information about cash inflows and
outflows and about who you owe and who owes you second if you ever need
external financing bankers or investors will insist on accurate financial
information they will need that information to assess business risk you
need that same information for that same reason and third taxes payroll taxes
property taxes income taxes the list goes on and on you need a system that
tracks your tax obligations to ensure that you pay the right amounts at the
right times if the government has to come in and do your taxes for you via an
audit remember they don't work for you they work for the taxing authorities
they will not be looking out for your best interest that will not be their job
so get yourself a system for tracking your inflows and outflows get a system
that will keep track of who you owe and who owes you get yourself a system that
will provide you with the information that you will need to better run your
business now about controls what are they
controls our procedures that should be in place to ensure that one the
information that is being collected in your accounting system is accurate and
reliable thereby helping you to run your business better and to to safeguard your
assets and your records now what sort of control should I have on information
that I will collect you will need to answer questions like how will you
document that your cash outflows our legitimate business expenses
you better have proper documentation if I'm in a business that has inventory for
resale how will I know how much I have on hand how do I know how many hours my
employees have worked you better have a system for tracking
this information and of course you will need a system that collects information
about your cash inflows and your cash outflows and you also need to know who
you owe and who owes you we've talked about that what else well you'll have
information that's confidential about employees pay rates Social Security
numbers etc that all has to be safeguarded what about customer lists
what about pricing information as you can imagine there's a lot of top-secret
information relating to the inner workings of your business that you don't
want getting out you need to ensure that you have systems that protect your
information and ensures that the system producing your information is accurate
and reliable one last thing to mention that is often taken for granted you will
need to safeguard your cash you will need procedures in place to
make sure that cash and checks are quickly and correctly deposited in the
bank and that only authorized expenditures are made this is no fun to
talk about but we tend to assume that those with whom we work are looking out
for the best interests of the company now that is often the case but is also
often not the case many individuals are looking out for them you need to make
sure that those individuals are never given the opportunity to be exposed to a
situation where they might compromise their integrity that is done by
developing a set of controls within your business to ensure that information is
collected quickly and correctly and that procedures are in place to ensure that
assets especially cash are handled properly now remember we said at the
outset that this topic is the no fun part of business no one likes to
talk about paperwork if you don't talk about and establish a system that
collects accurate information in a timely fashion and safeguard your assets
you will have plenty time to talk about that topic later when your business
folds up a good system of record-keeping and controls is what the scientists
would call a necessary but not sufficient condition a good information
system will not ensure the success of your business
but a bad information system will certainly contribute to your lack of
success you so what can be so hard about pricing a
product don't you just figure out what your costs are and then add some sort of
markup for profit oh that it were that easy if your price is too high
regardless of your cost someone in the market will enter price you assuming
that the quality of product or service is similar in many cases you will be a
price taker and you will have to manage your costs so that you can earn a profit
given a certain price is determined by the market now let me say that again in
most instances you don't price your product to cover your cost instead you
determine if given a certain market price your cost structure is such that
you can earn a profit the biggest mistake new business owners make in
product pricing is not considering and covering all of their costs when
entering a market now it is true that when you are initially trying to
penetrate a market you may be willing to lose a little money to gain market share
but that strategy is not sustainable over time over the long term you must
cover all of your costs all of your costs you now to our last topic uncontrolled
growth growth is awesome increased market share is good sales trending
upward is the dream and unmanaged growth has killed a lot of companies growth
must be carefully done or it could be fatal to your business the reason being
is that growth often requires cash and cash is often the one thing that new
businesses do not have a lot of in fact a lot of new business owners when faced
with the cash flow issues associated with starting a new business they
mistakenly think that the solution to their cash flow problems is to grow
faster not realizing that the fast growth is causing the cash flow problem
in the first place in other words they hit the gas when they should hit the
brake so how does growth cause cash flow problems well think about it in a
typical business that is selling a product to a customer on credit that is
the customer will pay and say 30 days you as the business owner need to pay
your rent pay your insurance pay your employees pay for the inventory that
sell that inventory and wait for 30 days to collect the cash to grow faster means
you need to buy and pay for more inventory and then sell that inventory
and wait for 30 days to collect the cash the more inventory you have to buy the
more inventory you have to pay for and then still wait 30 days to collect the
cash well let's just have our suppliers wait longer to collect from us until we
collect from our customers remember this your suppliers are having the same cash
flow issues that you are facing they would like to receive their cash sooner
rather than later so what should you do next that depends
on what you identify is your particular small business problem are you having
trouble with poor records are you finding your financial reports to be
uninformative or too often non-existent and like it or not you need to learn
something about accounting why are you having trouble managing your cash flow
are you always feeling cash squeezed with not enough financial capital to
invest in the assets information of people that you need and you need to
learn a little more about the field of Finance maybe you feel like you are
operating your business blind your profitability seems low but you can't
figure out why and you need some exposure to some simple techniques of
financial analysis finally remember that there are lots of qualified business
advisors out there sometimes it makes some sense to spend a little money to
meet with an experienced business adviser describe your business your
plans and your frustrations to the south side advisor she or he can then help you
sort through the weaknesses of your business to identify the things that you
need to work on first small businesses are the source of creativity in an
economy a small business is a precious thing the embodiment of a person's ideas
energies and ambitions I salute those of you who have the entrepreneurial spirit
and have started or thinking of starting your own small business I wish you great
joy and success you

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