The first step is to know what the basic elements of your company are and how they are categorised, in this way it will be easier for you to understand the finances of your business, as well as the documents to keep accounting records and later set long-term goals.
Therefore, we will begin by defining what the finances of a business are:
The finances of a business are the administration of inputs, assets and liabilities to guarantee the stability and / or growth of a business.
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The terms found in this definition may seem a bit technical, but do not panic below you will find we will explain what these elements mean:
What are business assets
They are the goods that belong to a company and must be categorised based on the time they are present in your business.
Fixed assets
They are those that will remain in the medium or long term (for more than a year) and this type of property in turn is divided into:
Material: They can be real estate, furniture or work equipment. For example, in a restaurant refers to tables, plates, cutlery, glass, kitchen equipment, etc.
Intangibles: They are rights or non-material elements and can be patents or the registration of a trademark.
Financial: It is the long-term economic capital that a company has.
Current assets
They are those that remain less than a year and are usually divided into:
Cash and banks: It is the money that is available for the operation in cash or in a bank account
Documents or Receivable Accounts: The money that you can demand for the sale of products, services or because you granted a credit. For this type of action, it is best to use documents that legally protect you, such as bills of exchange or promissory notes.
Warehouse or Inventories: These are all the goods that can be used for the production or sale of products. It can be raw materials, articles that are in the process of production, packaging, spare parts or goods already finished.
What are business liabilities
They are the loans or credits of your company. In other words, they are debts pending payment to suppliers, financial institutions, taxes and even social security. The liabilities of your company are categorised by the type of organisation to which you owe and you must divide it by the time it takes to fully finance that debt.
- Short term: For loans of less than one year.
- Long-term: Loans that you will finish paying in more than a year.
Why it is important to separate personal finances from your business
Now that we have seen what are the elements that are part of your company, we will talk about why it is vital that you make the separation, since this is one of the most common mistakes that entrepreneurs have, especially those who launch a business for the first time or they operate under the freelance scheme.
It may be very tempting to use business money to cover personal contingencies, but this is a habit that could affect you, since if you mix personal expenses with those of the business, it will be very difficult to prepare the records that help you know how your business behaves and whether it is profitable or not.
Think that in the early stages of your venture you will have fixed and variable costs, consequently if you use the same account to spend that money it will be more difficult to know when your business reaches the breakeven point where it does not lose money, as well as the moment start to make a profit.
In summary, if you get used to covering costs of your company with personal money, you will not be able to say with certainty if it is profitable and you could even negatively impact cash flow, strategic planning to grow the business, as well as cost optimisation.
Remember that when you make a profit in your business you should think about how you are going to invest that money to make it grow more, in addition to that you should always have savings to face a crisis. This is why it is not recommended that you use your earnings to pay for personal expenses.
What type of records should a business keep?
In the previous sections we saw basic elements of financial education (what are the elements of your business and why it is important to have an adequate record) that will help you better manage your business.
Now, it is time to say explain are the 3 basic documents that you must have in your company to understand the complete picture of what is happening. These are:
- Balance sheet
- Statement of income
- Cash Flow
Balance sheet
It is the document that reports the assets, liabilities and capital of a company. It is used to show the current situation of a business (no matter what size it is). Think of it as a photograph that shows what you have, who is owed, how much is owed, and summarises whether the business made a profit or loss.
In the previous sections we saw what the assets and liabilities of your company were, but you may be wondering what the capital part refers to. This is the money that you contribute as an entrepreneur and / or your partners.
To make it a bit clearer, here are what a balance sheet document looks like and some very simple tips on how to read it:
Let’s say that you gave 50 thousand dollars for the business, that money will be reflected in the capital part and the banking part. On the other hand, your partner contributed raw material valued at 200 thousand dollars, that in the assets part should be placed in the inventories section.
If you had a credit of 15 thousand dollars, you would put it in the liabilities part and you should also incorporate that money to the assets in bank accounts, because it is money that you will have available in that bank account.
Surely you are wondering why the elements of liabilities to assets or capital to assets are repeated. Remember, in the end these sums of money translate into liquidity so that your business can operate.
In fact, something very important that you must take into account when reading a balance sheet is that the sum of the liability + the capital must be equivalent to the total of the assets.
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