The term business finances refers to the assets, liabilities, capital, revenue and expenses of the business. For you, “expenses” may or may not literally include taxes, but however you want to slice it, taxes and tax considerations obviously have a big impact on how businesses are organised and run. These financial components are tightly intertwined with each other and with the operational decisions made by the business.
1. Capital Purchases & Assets
Almost all businesses need to acquire and use fixed assets. The acquisition can be through purchasing, renting or leasing. Purchase and lease decisions in turn require ROI analysis and financing decisions. Then, once an asset is acquired, it must be recovered, or expensed, over time to reflect its depreciation and plan for its replacement. The financing and cash flow decisions involved in acquiring assets will affect both business operations and owner finances, especially in proprietorships, partnerships and closely held corporations.
2. Capital Structure
Capital structure refers to how much of the business financing is through owner equity and how much is through debt or other liabilities and how it is done, that is, the mix of financial instruments and ownership vehicles. Business capital requirements and owner decisions influence the capital structure, which in turn influences the owner’s personal finances. Entrepreneurs must decide how much of their own capital to invest in the business, how they will be “paid” for that capital (in profits, wages, interest, or other ways) and how procuring capital through loans will affect their own financial well-being.
3. Working Capital
This is a tough concept for many entrepreneurs to grasp. It is capital used to finance the flow-through, what goes into the business and what goes out of the business – not the fixed or tangible assets of the business. It is used to pay for inventory and to provide cash for other items necessary for the day-to-day running of the business. Any business that must pay a supplier or an employee before providing a product or a service to its customers or must provide a product or a service to customers before receiving payment needs working capital to make this happen.
Working capital is part of the total capital required to run a business – and the most dynamic part. Insufficient working capital can choke business operations– insufficient inventory, inability to offer satisfactory customer purchase terms, inability to pay employees or suppliers. It is very common for entrepreneurs to underestimate the need for working capital. The usual result is that the owner must kick in more capital from personal finances– or accumulate more debt. Working capital mismanagement is a common cause of personal financial failure for entrepreneurs.
4. Cash Flow
This is the bigger picture for working capital. Does the business have enough cash to meet its ongoing business needs? Does it generate enough cash through operations to replace assets, pay its owners, and fund its growth? Poor cash flow leads to inadequate business resources. It can cause many financial problems, from decreases in owner returns to severe shortages of capital that must be met eventually by the owners.
Cash flow becomes especially critical when the owners must replace key assets or as they’re implementing important growth and competitive strategies. Many a business has declined or failed because of inadequate cash flow to replace assets or to execute key competitive strategies.
5. Risk Management
We mentioned risk under Business Operations, but any business faces various financial risks. Customers don’t always pay, interest rates don’t always stay the same, tax rules change, sources of funds don’t always come through as expected, owners or investors can leave and the list goes on – all with obvious personal financial consequences.
As an entrepreneur you will make hundreds to thousands of operational decisions in setting up an infrastructure and producing your product or service.
All decisions that involve money involve the finances of the business, of course, and many, like employment and facility decisions, will affect your personal finances as an owner. And these decisions are never finished, they will adjust and evolve as your business evolves – and so will your business and personal finances. Business operational decisions include the following:
1. Employment & Employees
Whether to have employees, how many, and what kind of compensation to provide are decisions that affect business finances in obvious ways. Decisions about employee benefits and retirement plans will affect you, for whatever you decide to do for them may have consequences for you: You can participate in benefit and retirement plans, often to your advantage. Also, your decision on how to engage yourself and your spouse and/or family members as employees can impact your company finances.
2. Facilities & Location
Early on, you’ll have to decide what kind of location and building your business needs. That decision will probably have to be modified as the business grows and evolves. Naturally, like employee costs, facility costs are a major factor in the finances of most businesses. But key decisions on building ownership– buy vs lease, owner buys and leases to business – are important for personal finances. Depending on the business, many entrepreneurs look to buy their facilities to build the asset base as part of a retirement or other exit strategy for the business. In addition, the use of a home or other personal space in a business has important personal finance consequences.
3. Growth strategy & Plans
Every viable business has a strategy and a plan to grow and evolve. Decisions on how to evolve and how fast must be made in the context of both business and personal finances. Many good businesses fail because they grow beyond the asset base and working capital required to support them.
Every entrepreneur must decide how to organise his or her business. Not only are we talking about organising facilities and human resources, but also the basic legal structure of the business. The decision of whether or not to incorporate is important. If the decision is not to incorporate, important decisions must be made between or among partners, if there are partners, and contingency plans must be in place in case things change. Like most operational decisions, the organization decision is never finished.
Every business has risk and there are several kinds of risk. Operational risks – the risk of accident, mistake, or omission – produce potential liability for the business and can produce liability for the owners, depending on how the business is structured. Continuation risks concern the ability of the business to function in the case of unexpected catastrophe or unavailability of a key employee or owner. Financial risks concern the capital structure and the availability of capital and are covered below. Many of these risks are assumed and covered at the business level, but the owner must consider the risks at the personal level as well.