Financial Literacy: Entrepreneurs must learn how to manage money

Nov 12, 2017 Features / Columnists, News

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Learn how to read, interpret and use financial statements
Running a small business requires a wide range of talents and skills, including an understanding of how to read, interpret and use business financial statements.
In fact, Intuit Canada, an Ontario-based accounting software firm, performed a survey of small business owners and found that 57 percent were unable to pass a short multiple-choice financial literacy test.
When it came to testing entrepreneurs on their knowledge of specific concepts, the survey found that only 26 percent understood the purpose of a balance sheet.
The literature seems to indicate that most entrepreneurs start businesses based on an idea or some level of pre-existing expertise, not financial knowledge. Therefore, entrepreneurs are intimidated by their accounting and must learn how to record and track business income and expenses appropriately.
They must also learn to read, interpret and use business financial statements. The three major financial statements are the income statement, balance sheet and cash flow statement that comprises a “financial report card.”
Financial components that business owners should understand and monitor
Some experts suggest that weak financial literacy may be the single biggest reason why small businesses do not succeed. Therefore, financial literacy education should start as early as possible to equip entrepreneurs with the ability to make sound financial decisions.
Entrepreneurs face many challenges managing their money. In this regard, there are three basic financial components these business owners should understand and monitor:
1. The Balance Sheet: A Statement of Business Health – The balance sheet presents a company’s financial position at the end of a specified date providing a snapshot of the company’s assets, liabilities and shareholders’ equity.
On the asset side of the balance sheet is an accounting of key metrics such as cash, accounts receivable, inventory, and capital assets such as equipment, furniture and machinery. The opposite side of a balance sheet lists liabilities such as accounts payable, taxes, payroll deductions and loans. The equity is the difference between assets and liabilities.
The balance sheet is the financial statement bankers like to focus on because they believe it offers clues about basic business health. Balance sheets matter because they provide insight into the availability of funds to operate the business in the short term while allowing you to make predictions based on current financial performance.
2. The Income Statement: The Bottom Line – The Income Statement reports the flows of receipts generated by the business and the flows of expenses incurred to produce and finance the company’s operations. It also shows net profit or loss incurred over a specific accounting period.
According to Investopedia, financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. Unlike the balance sheet, which covers one moment in time, the income statement provides performance information about a time period.
3. The Cash Flow Statement – Cash flow is essential to small business survival and is a measure of a company’s liquidity, consisting of net income plus noncash expenditures (such as depreciation charges). Cash flow is determined by looking at three components by which cash enters and leaves a company – operations, investing and financing. For a more in-depth understanding and background reading on the Cash Flow Statement please see Analyse Cash Flow the Easy Way at Investopedia.com
The cash flow statement is distinct from the income statement and balance sheet because it does not include the amount of future incoming and outgoing cash that has been on credit. Therefore, cash is not the same as net income, which on the income statement and balance sheet, includes cash sales and sales made on credit.
Concluding remarks
A good set of financial projections should include an income statement, balance sheet and cash flow statement. According to Barron’s review books on finance, there are several ways to evaluate the performance of a business. One approach is to analyse its financial statements.
This can be accomplished by at first studying the contents of the income statement, balance sheet and statement of cash flows. Secondly, an analysis of the statement of cash flows must be performed. Finally, an examination of the relationship between the income statement and the balance sheet must be performed by engaging in “ratio analysis.”
The ultimate purpose of analysing financial statements by these procedures is to help business owners achieve sound planning. By studying income and balance sheet statements, business owners can spot areas of weakness in financial operations and take appropriate remedial action.
Through the analysis of these statements business owners can establish a more effective way of allocating funds and resources.
Finally, another way to measure the well-being of your business (not discussed above) is to understand what working capital is and why it is an important part of the day-to-day operations of your company.
Working capital lets you know if you have enough money to meet the financial obligations of the business over the short term. The way to determine the working capital of your business is to subtract current liabilities from the current assets.
Next week we will examine some more aspects of financial education for entrepreneurs.

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