The Ultimate Guide to Managing Small Business Finances

Some small business owners are already financial experts: they have MBAs, experience in the private sector, and strong literacy in all things related to managing small business finances.

This guide, however, is for the business owners with little-to-no finance experience—the ones who had a passion or a big idea and decided to go for it, but who are now wondering how to manage small business finances effectively (or at all!).

If managing finances for a small business has you feeling completely overwhelmed, take a look at this comprehensive primer. Get ready to learn about need-to-know accounting terms, managing your credit scores, applying for a business loan, and more so you can feel prepared for managing finances for a small business.

Part 1: Business Accounting 101: How to Organize Your Business Finances 

We’ll start our guide to managing small business finances with the basics of small business accounting. If you’ve never taken an accounting class, this will provide a basic review of accounting terminology, documents, and accounting software options, as well as tips on when and how to bring in a professional.

Key Business Accounting Terms to Know

As you dive into the world of small business financial management, there are several buzzwords that will likely come up over and over again. If you don’t know the terminology, everything you read about managing your small business finances will feel like it’s in a totally different language. Let’s begin your adventure into financial literacy with a few basic terms:

1. Gross Revenue

Also called total revenue, your gross revenue is the sum of all monies you’ve received from customers in exchange for your product or service, before taking any deductions or expenses (such as rent, cost of goods sold, taxes, etc.).

2. Expenses

In the simplest terms, expenses are everything that keep your gross revenue from going straight into your pocket—things like rent, payroll, costs of materials for goods sold, taxes, interest on debt, and utilities and other operating expenses.

3. Net Profit

Sometimes called the bottom line, net income, or net earnings, net profit is essentially what is left over after you deduct your expenses from your total revenue. When this number is positive, it means that your revenue is greater than your expenses, and your business is profitable.

4. Cash Flow

Beyond basic profitability, having enough cash on hand can often make or break the success of a small business—even if your business is profitable, you can run into issues if you don’t have enough cash in your bank account to pay your bills.

Your cash flow is the difference between the available cash at the beginning of an accounting period compared with at the end of the period. Cash comes in from sales, loan proceeds, investments, and the sale of assets, and goes out to pay for operating and direct expenses, principal debt service, and the purchase of assets.

5. Break Even Point

For the first several months (or even years) of doing business, many small businesses will operate at a loss—meaning their expenses are greater than total revenue. The break even point is production level at which total revenues equals total expenses. This is typically the turning point to profitability—an important milestone in the life of every small business.

Your 4 Most Important Business Accounting Documents

Managing a small business involves a lot of paperwork. You’ll need accounting documents to file your business taxes, apply for business financing, and for internal tracking of your revenue, expenses, and profitability. These are the four main accounting documents that every small business owner should regularly maintain:

1. Balance Sheet

The balance sheet is essentially a snapshot of your business’s financial standing at a given moment. It lists the assets, liabilities, and equity your company holds, and is used to calculate the net worth of your business.

Maintaining a “balanced” balance sheet—one in which total assets (everything your business owns) equals liabilities plus equity—is the foundational tenet of basic bookkeeping.

2. Income Statement

Sometimes called a profit and loss statement, your income statement summarizes your business revenues and expenses over the course of a year, allowing you to calculate your net profit or loss for that year. Maintaining an accurate income statement is critical to determining the break even point for your new business, as well as measuring profitability over time.

3. Cash Flow Statement

We discussed that having enough cash on hand to cover expenses can make or break a company’s financial health—and in fact, this issue is so important that there’s an accounting document dedicated to the tracking of cash flow.

Your cash flow statement reflects the inflow of revenue and outflow of expenses resulting from all your business activities during a specific time period—usually a month or a financial quarter. Inflow will come from selling goods and receiving payment on invoices, while outflow comes from things like purchasing inventory, payroll, and paying marketing costs and other overhead expenses.

4. Revenue Forecast

Can you afford to hire a new employee or launch a new marketing campaign? If you were to take on a business loan in the coming months, what monthly payment amount could you reasonably handle? These questions, and many more, cannot be answered with any degree of accuracy without a revenue forecast.

A revenue forecast is an educated prediction for the upcoming year about how much money your company will likely bring in, so that you can estimate what you can afford to spend, and what your profit margin will be. The more thoroughly researched and realistic your forecasting is, the easier it will be to stay on budget throughout the year.

The Best Small Business Accounting Software Right Now

Keeping track of your accounting documents above can become overwhelming if you’re trying to manage everything manually.

Thankfully, there are several great accounting software options available that will take the guesswork out of your bookkeeping. Using these cloud-based software services, you can have all of your most important accounting documents just a few clicks away, generate them automatically, and handle invoicing and other bookkeeping needs.

Check out our favorite cloud-based accounting options for small business owners:

QuickBooks Online

QuickBooks Online is simple enough for small business owners to use, but accountants love it, too. You can view the status of your finances at a glance using dashboards, or create customized reports. You can also generate invoices, accept payments, process payroll, and import expenses by simply taking pictures of receipts with your phone.

Plus, QBO syncs with your bank accounts and credit card accounts so data is always up to date. You can also share QBO with your accountant to simplify tax time.

Pricing starts at $15 per month.

FreshBooks

FreshBooks started out as an invoicing and expense tracking product, but has now expanded to include bank account integration, report creation, payroll processing, and time tracking. This accounting tool targets people who want a very simple accounting software and free customer support from real people. It also integrates with popular apps for CRM, customer service, and more.

Pricing starts at $15 per month if you pay month-to-month, or $13.50 per month if you sign up for a yearly membership.

Xero

This fully featured accounting tool also uses dashboards, generates reports, creates invoices, handles payroll and expenses, and syncs with your bank account. The biggest differentiator? You can add as many users as you want for free. Xero integrates with a the largest range of add-ons to automate tasks such as time tracking, mobile payments and more.

Xero’s pricing starts at $9 per month for their basic plan.

The Best Way to Keep Track of Small Business Finances? Hire a Business Accountant

While the right accounting software can work wonders to help you manage your small business finances, there are some areas of accounting that are beyond the capacity of the average small business owner. It’s in your best interest to hire a professional accountant to review your books for errors at least annually, help with tax filings, and make recommendations for major financial decisions.

Ask your business attorney, banker, or a fellow business owner for a recommended accountant, or contact the Society of Certified Public Accountants in your state for a referral. The person you choose should be a certified public accountant (don’t assume every accountant is) and licensed to practice in your state. Ask if you can call a few clients to check references, and make sure you are clear about the individual’s fees for services.

In addition to these basics, building a great accountant-client relationship requires the right personality fit. How accessible will your accountant be to answer questions? What areas of your finances will he or she handle, and what will you keep in house? Limit future confusion by discussing each of these issues before you make a selection.

No matter what responsibilities you decide to hand over, it’s essential that you stay personally involved in your small business finances, and that you have checks and balances in place to avoid business identity theft or fraud. While you may be eager to get as much financial management off your plate as possible, being too hands-off with your small business accounting can make you a target for individuals with unsavory intentions.

Part 2: Managing Finances for a Small Business Means Paying Business Taxes

Along with getting your books in order, understanding and fulfilling tax requirements should be a priority in your business financial management. The consequences for failing to file your state and federal business taxes are severe—as in you could lose your business and even face criminal charges. Though dealing with the IRS can be intimidating, this isn’t something you can ignore.

Here’s what you need to know about paying business taxes:

Obtain Your Federal Tax Identification Number

Also known as your employer identification number (EIN for short), this number helps the IRS keep track of your business for tax purposes. Think of it like a social security number for your business.

While not all businesses need to apply for an employer identification number, there are some circumstances where you may need to file for an EIN even if you don’t retain employees—especially if your business is established as a corporation or partnership. Consult the IRS website to determine whether or not you need an EIN.

Understand Federal Business Taxes

There are four general types of taxes levied by the federal government, and the type of business you run determines which taxes you must pay, when forms and payments are due, and how you’ll file those taxes. While not every one of these four types of business taxes applies to every business, it’s important to know what they are, and understand how they might impact your small business finances.

Income Tax

All businesses must file annual income tax returns and make payments based on revenue received. The exact tax form you use to make income tax payments depends on the structure of your business: sole proprietorship, partnership, corporation, S-corporation, or LLC.

Business income taxes are “pay-as-you-go” taxes, meaning you’ll need to make estimated tax payments quarterly. (See below for additional information about filing estimated taxes.)

Self-Employment Tax

Individuals who work for themselves must pay Social Security and Medicare taxes via a self-employment tax. This tax is similar to the taxes withheld from the pay of most wage earners.

Estimated Tax

Income and self-employment taxes both qualify as “pay-as-you-go” taxes. You’ll need to file quarterly documents estimating the taxes you owe and make payments accordingly.

Employment Taxes

If you have employees working for your business, you will have additional tax obligations related to those employees, including social security and Medicare taxes, federal income tax withholdings, and the federal unemployment tax.

Excise Tax

Depending upon what type of business you run, what products you sell, and the types of equipment you use, you may or may not be required to pay excise taxes for your business. Excise taxes most often apply to businesses with heavy fuel usage, but can also apply to such businesses as indoor tanning salons, manufacturers of archery equipment, and more.

Your State Tax Obligations

In addition to federal business taxes, most U.S. states and territories will require you to pay income and employment taxes for your business. Certain states have additional fiscal requirements, such as state mandated workers’ compensation and unemployment insurance.

Registration, requirements, and filing procedures vary widely from state to state, so click here to access business tax information specific to where you live.

Part 3: Get a Handle on Your Credit Scores

Whether it’s a property or equipment lease, a business credit card, or a small business loan, at some point over the life of your business you’ll need access to credit. Your ability to qualify for business credit of any kind will be dependent upon your personal and business credit rating and history—and both scores are inherently tied to how well, or poorly, you’re managing finances for a small business.

Here’s what you need to know about maintaining solid personal and business credit to maximize future borrowing options for your small business.

How to Manage (and Boost) Your Personal Credit Score

As the business owner, your personal credit history has a huge impact on your business’s ability to qualify for credit products. Even if your business has great credit, lenders will look into your personal credit as a measure of your ability to pay back a business loan—and the higher your personal credit score is, the more and better loan products you’ll have available to you.

So, managing your personal credit rating is a key component of how to manage business finances effectively. Here are some tips on improving or maintaining that all-important number (and even attaining a perfect credit score):

• Pay all your loan bills in full and on time
• Avoid FICO demerits like loan defaults, bankruptcy, judgments, collections, and foreclosures
• Keep spending on all your credit and store cards as low as possible in relation to your credit limit
• Don’t max out your credit cards
• Monitor your credit reports regularly for any discrepancies or irregularities, and contact the bureau ASAP if you find a mistake
• Having a mix of credit is healthy for your score—but only if you can reliably repay all that debt!

Beyond this, there are a few other “hacks” that may offer a quick boost to your credit score, such as increasing your credit limit (without increasing your spending), and addressing dormant accounts that may be hurting your rating. But overall, the best thing you can do to maintain a great personal credit score is to make all debt payments on time, every time—both in your business and for your personal finances.

How Your Business Credit Score Works

In addition to your personal credit score, as a business owner you’ll also want to establish business credit, which you can start doing after you’ve obtained an employer identification number. Like your personal credit score, your business credit score is a measure of how well or poorly you honor your debts, and it’s an important factor in determining your eligibility for future business financing—but this time, it’s your business that’s under the microscope, not you as an individual.

In this case, the credit bureaus cull information about accounts held under your business’s name, from sources including your vendors, trade associations, business credit card companies, and business lenders. Dun & Bradstreet is the leading resource to monitor your business credit rating, which you should do at least every six months if you plan to apply for financing in the future. If you encounter an error, contact the agency for a correction.

Part 4: Understand Your Business Loan Options

At some point in the financial trajectory of your business, it’s likely that you’ll need to seek financing in the form of small business loan—whether that’s to deal with short-term cash flow challenges, or to fund the growth of your business.

Every type of business loan and lender has different eligibility requirements, including minimum credit scores and annual revenue. Understanding the types of loans out there, and what you’ll need to qualify, can help you better organize your business finances from the start of your venture—and give you a financial goal to work toward as you build.

Types of Small Business Loans

Brick-and-mortar banks used to be the only game in town for small business borrowing. But in the wake of the 2008 financial crisis, more and more small businesses have been unable to qualify for funding through traditional banks. This challenge, along with over-regulation by traditional banks, gave way to a boom in online alternative lending to fill the gap in availability of small business funding.

That’s not to say you can’t still secure a loan through a traditional bank. If your business has been operating for a while and you have a solid credit rating, a traditional bank may be able to offer you great terms. But if your credit is less than stellar or you’ve been turned down by your local bank, now there are other options available.

While traditional banks tend to have pretty stringent and specific terms for what loans they will and won’t approve, many alternative lenders are willing to consider a wider variety of factors in making loan approval decisions.

With the exception of SBA loans, the loan eligibility standards we’re mentioning here are based on loans offered by alternative lenders, not by banks.

Term Loans

A term loan is likely the first thing you think of when you imagine business lending. Term loans offer a set repayment time, set number of monthly payments, and have a fixed or variable interest rate. Depending on your business needs, credit rating, and other factors, there are a wide variety of term loans available to many small business owners, with terms ranging from one to five years.

Most approved borrowers of term loans we’ve seen have had the following stats:

• Annual revenue: $300,000+
• Credit score: 680+
• Time in business: 3+ years

Equipment Financing

If you’re looking for financing specifically to purchase equipment for your small business—including computers, machinery, and much more—equipment financing may be the right choice for you.

Equipment financing works very similarly to a car loan. The amount you can borrow depends on the price and type of equipment you’re borrowing, and because the equipment itself serves as collateral, you likely won’t be asked to put up additional collateral. Equipment financing terms typically work at a fixed interest rate—usually between 8% and 30%—with a fixed term length so your payments will be the same from month to month.

Most approved borrowers for equipment financing had these stats:

• Annual revenue: $130,000+
• Credit score: 630+
• Time in business: 2+ years

Short-Term Loans

For businesses with relatively small and immediate financing needs, short-term loans can be a lifesaver. These loans work similarly to traditional term loans, but cover amounts in the $2,500 to $250,000 range with terms of between three and 18 months. Short-term loan providers can often get you cash in hand in as little as a single day, allowing you to make rent, cover payroll, or meet other immediate overhead expenses even when sales are slow and cash is tight.

To be eligible for short-term financing, you might need stats similar to these:

• Annual revenue: $150,000+
• Credit score: 600+
• Time in business: 2+ years

Business Lines of Credit

Other than a business credit card, you’d be hard pressed to find a more flexible funding source than a business line of credit. With these replenishing resources, lenders give business owners access to a predetermined amount of funds, from which they can draw down whenever they want, and in whatever amount they need. You’ll only need to repay the funds you use, plus interest. Use your line of credit to cover unexpected expenses, payroll, general working capital, or to take advantage of sudden opportunities.

If you’re interested in applying for a business line of credit, your lender might be looking for stats like these:

• Annual revenue: $180,000+
• Credit score: 630+
• Time in business: 1+ years

SBA Loans

The SBA is a great resource for small business owners for everything from writing a business plan, to finding a business mentor, to assistance with securing financing for your small business. However, it’s a common misconception that the SBA itself actually loans funds to businesses.

In reality, the role of the SBA in the SBA loan model is to guarantee a percentage of the loan on behalf of the borrower—meaning if you default on your loan, the SBA promises the lender that it will cover the cost up to a certain amount. (But the loans are financed by banks or other lending institutions, not by the SBA itself.)

While this guarantee may make some lenders more willing to consider applicants who don’t fall within their strict loan criteria, applying for an SBA loan still involves lengthy paperwork, and the process can take several months. If you apply, lenders will review your personal and business credit histories and financial statements, and they may require collateral to secure the loan. Despite the government guarantee, not all small businesses qualify for SBA financing.

The SBA offers a variety of loan programs to suit a variety of different business demographics and needs, but the most common is the SBA 7(a) loan, which provides business owners with basic working capital.

In addition to meeting basic SBA loan eligibility requirements, most approved SBA 7(a) borrowers came to their lenders with stats along these lines:

• Annual revenue: $180,000+
• Credit score: 680+ (but the higher, the better)
• Time in business: 4+ years

A Note About Collateral and Personal Guarantees

To mitigate the risk of borrower default, many lenders will require small business owners to offer collateral or a personal guarantee in order to be approved for funding. Collateral refers to a specific asset that is leveraged to guarantee a loan—such as your house or other high-value personal property. If you put up your house as collateral and then fail to pay back your small business loan, the lending institution can hire a lawyer, get a judgment in their favor, and repossess that property as repayment for the loan.

By contrast, signing a personal guarantee means that the lending institution can leverage any and all assets you have now and in the future to seek repayment for a defaulted loan—either up to a fixed, pre-determined amount (limited personal guarantee) or for the full amount of the loan and interest owed (unlimited personal guarantee). This may include your life savings, retirement, personal property, your children’s college fund, and in some cases even assets owned in your spouse’s name.

Because the terms are more ambiguous, personal guarantees are generally riskier for borrowers than a standard collateral agreement.

Even if you have full confidence in your small business’s prospects for success, signing a collateral or personal guarantee agreement has serious implications on your financial future. Make sure you understand exactly what you’re signing and that you’re comfortable with the terms.

Alternatives to Debt-Based Loans

Small business loans aren’t the only way to finance your small business. Here are just a few of the alternatives you might consider to cover the initial costs of your latest business venture—and which you’ll likely have an easier time being approved for when you’re starting up:

Capital Investors

Every day, thousands of investors and venture capitalists are contributing both finances and expertise to what they see as the “next big thing.” If your business idea has a high chance of profitability, you may be able to spark the interest of an equity investor, such as an angel investor.

Friends and Family

If your family and friends seem supportive of your business venture, they may be willing to invest funds to help your business succeed. Of course, accepting funds from friends or family comes with its own set of challenges. Even when everyone has the best of intentions, loss of income from a failed business deal can ruin relationships.

Should you choose to go this route, do everything you can to keep it professional. Offer a professional-quality investment proposal as you would to any other investor, and set the exact terms of the investment in writing. That way, you’ll face less risk dealing with miscommunications or relational challenges down the line.

Crowdfunding

Maybe you have a network full of acquaintances and contacts willing to contribute to your business venture in smaller amounts. Don’t underestimate the value of a few hundred $50, $20, or even $10 pledges towards your overall fundraising goal. That money adds up fast. And if your campaign goes viral—catching the attention of folks outside your immediate network—the possibilities grow even further.

Platforms like Kickstarter and IndieGoGo are great for smaller ventures seeking contributions. Larger-scale ventures might consider equity crowdfunding platforms like EquityNet, which sells company equity to capital investors in a crowdfunding format.

How to Organize Your Business Finances So You Can Afford Your Loan

The available options for funding your business may have you dreaming of possibilities for growth. But before you can move forward, it’s important to determine what your loan costs, and whether or not you can afford it. Here’s what you need to know in order to analyze the affordability of your potential small business loan.

Managing Payments and Amortization Schedules

Make sure you understand the terms of your loan before you sign, and use a loan amortization schedule ahead of time to determine what your payments will be. Depending on the terms of your loan, you may be expected to make monthly, weekly, or even daily payments on principal and interest. For some loans, your payments will be a fixed amount every period, while others will fluctuate over the life of the loan.

If you’re managing debt from multiple sources—such as a business loan, business credit cards, and lease payments—our business debt schedule template can help you track payments and make sure that you have the cash on hand to cover all payments as they are due.

Calculate Your Debt Service Coverage Ratio

In a business context, the debt service coverage ratio (DSCR) is the ratio of cash a business has available for servicing its debt. Lenders use this ratio when reviewing your loan application to determine whether your business can afford the loan you’ve applied for.

To calculate your debt service coverage ration, first calculate your EBITDA (earnings before interest, taxes, depreciation, and amortization), then divide that number by the sum of your interest and current maturities on long term debt. If you’re looking at applying for a particular loan, factor the terms of the loan into the equation to see how it affects your debt service coverage ratio.

Typically, lenders look for a ratio of at least 1.25. This demonstrates a cushion so that if you have a slow sales month or an unexpected expense comes up, you’ll still be able to make your loan payment. If you’d like to be more conservative, aim for a loan that leaves you with a DSCR of 1.35 or even 1.5.

Complete a Loan Performance Analysis

Even if you can technically afford to make monthly payments on a business loan, that doesn’t always mean that taking on the loan is a good idea for the financial future of your business.

Using basic information about your loan—including the amount, interest rate, and term—as well as basic revenue information about your business, you can complete a loan performance analysis to estimate when you’ll break even on the cost of the loan, your expected monetary gain, and the approximate profitability of your loan on a five- or 10-year horizon. If the impact over your preferred time horizon is profitable, then that might be a good reason to take the loan.

How to Organize Your Business Finances, One Step at a Time 

For a rookie entrepreneur with little or no business education, all of this information can be daunting. If you’re overwhelmed, contact SCORE or a Small Business Development Center for information about being paired with a mentor. Working with a veteran entrepreneur one-on-one is a great way to overcome the learning curve associated with managing small business finances.

Above all, remember: the transition from managing your receipts in a shoebox to professional-level business financing doesn’t have to happen overnight—it’s a step-by-step process.

But at every turn, keep your personal and business finances separate. So as soon as your venture has opened its doors (either physical or digital), apply for a business credit card and a open a business bank account, making sure to use each only for your business expenses. Not only will this separation make organizing your business finances a whole lot easier, but it can set you up for greater success in securing a small business loan down the line.

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