Finance 101 for the Small and Medium Business

Whether you’re starting a small or medium-sized business or an online operation, the key to success is the same: knowing how to responsibly manage your finances. Let’s say you’ve got a great idea for a business. Let’s also say that market studies project a high probability of success and that you’ve found the money to get started. But you haven’t thought much about the financial challenge presented by the day-to-day operation of a business. You presume that all you need to know is what “everybody knows”: Don’t spend more than comes in, and manage a profit in the process. Whether you’re thinking about developing a small or medium-sized business or setting your operation up online, the following concepts will help you manage your business’s finances intelligently.

This is the money that every business, whether a small bricks-and-mortar enterprise or an operation in the digital marketplace, needs to get started. The initial investment can be required for two reasons: to purchase assets or to cover primary operational costs. “It looks simple, but it isn’t,” explains Javier Hernández, director of the Business Administration department at the Universidad del Sagrado Corazón. “Purchasing assets is an investment, but expenses are just that—expenses, and they’ll never be recovered. A stove or a computer is an investment, but buying materials or paying rent is an expense,” he continues. Distinguishing between purchasing assets and covering operational costs during the first months of a business (salaries for the wait staff and cooks, for example) is key, because it defines the “risk picture”: that is, the higher the initial operating costs, and the longer that initial period lasts, the lower the probability that a bank will grant you a loan, so the probability of failure increases.

Knowing how much money is needed for starting your business is one thing, and identifying where you’re going to find it is another. There are three ways to raise capital: with your own money (including donations, whether online or by other means), with loans, or with investments. Nothing keeps you, Hernández notes, from using a combination of the three, so that, for example, 75% of your startup funds come from donations, loans, and investments and 25% from your own money. To return to our example: although it’s possible that a bank will not lend money to cover high initial operating costs, it may well do so if it’s offered collateral, such as other assets, for that initial investment or loan. In the process of finding financing, you should also look for government incentives and aids you might apply for depending on the type of industry your business falls under, Hernández stresses.

If you know how much money you need and how to find it, you come then to the crucial step: drafting a budget.

“A budget allows you to plan the operation over future periods, whether months or years, by projecting income and anticipating expenses. To the degree you’re able to budget, you can predict your cash flow,” Hernández explains.

He points out that the budgeting process follows the same rules in the analog world as in the digital realm: “A shop doesn’t have to devote much of its money to marketing itself, perhaps, but there’s a lot of money devoted to employee salaries, while a person who is his or her own boss and has a shop online doesn’t spend much on payroll but a lot on marketing,” he says.

According to the Small Business Administration and the Minority Business Development Agency, budget solvency—and therefore operational solvency—is maintained by keeping a record of every financial commitment you make (“bookkeeping,” in accounting terms) and preparing a quarterly or yearly cost-benefit analysis. This analysis is, in the end, the most useful way to determine whether your business has a chance.