Understanding the basics of business is important for any professional hoping to succeed as a small business owner or manager. If you're hoping to become a small business owner, you may benefit from learning the basics of small business finance. Knowing the foundations of a business' financials is essential in running it in a cost-effective manner.

In this article, we explore why it's important to understand business finance basics and discover a list of 13 basics of small business finance.

Why is it important to understand small business finance basics?

There are a variety of different reasons that it's important to understand small business finance basics. Educating yourself on the foundations of business finance can assist you in gaining the skills for operating a small business. Knowing how and why you may complete certain business finance tasks — such as crafting financial statements, managing payroll or determining salaries — is essential in creating a stable financial situation. Knowing how to properly track business finance activities and keeping them organized may allow you the opportunity to better run the business and set it up for a lucrative future.

13 basics of small business finance

Here are overviews of 13 different basics of small business finances:

1. Keep extra cash available

It's important to always have extra funding available for your business to use if you encounter unexpected financial circumstances. These circumstances may take a toll on your financial resources, so having extra cash available to handle them can be helpful. It's generally recommended that you keep about three to six months' worth of funds to cover all business expenses readily available at all times. The more funds you have available to deploy in case of an emergency, the better.

2. Determine price for profit and cost of selling goods and services

Determining the long-term costs of anything that the business purchases helps you accurately plan your financials. This may include costs for goods, services or other materials you need to create your products. Your selling prices are to cover any expenditures the business makes, so you sell products, programs and services for more than it costs you to create them. Once you determine these expenses, you can set selling prices that earn you a profit. Because of this, it's important to determine the following expenses:

• Payroll expenses for staff members
• Operating costs such as utilities, assets and rent
• Preparing and packaging costs
• Logistics expenses
• Mailing expenses

3. Establish where you're spending money

Knowing exactly where expenditures occur is essential in having a good understanding of a small business' financials. It's important to track exactly where the business spends money for both accuracy and long-term planning. Categorizing the costs, such as segmenting them by business purpose, can be helpful. Doing this helps you implement proper controls for expenses and calculate overall profit margins.

4. Continuously prepare for tax season

Preparing for tax season continuously is important in ensuring that all of your financial records are in order when the time comes to file taxes. Preparing your books as every transaction occurs can help you do this. Recording all financial actions as they occur can save you time and effort later when you use this information in your tax return.

5. Maintain staff work forms

If you're a business owner and have even just one staff member, you file forms and payroll taxes. You're required to maintain forms that hold staff information such as employer matching, unemployment, withholding and worker's compensation. It's important to also check with the state you live in to learn about specific tax obligations for which you're responsible.

6. Keep excellent business credit

Keeping an excellent business credit score helps you take out loans, receive approval for funding, acquire insurance policies or purchase real estate. To ensure that the business has good credit, it's a good idea to pay off all your debt as quickly as possible. You also try to keep the amount of debt the business has as low as possible. You can also try to avoid taking out loans that have interest rates that you can't afford and use funding that you're most likely to be able to pay off easily and within a timely manner.

7. Take out loans

It many cases, it can be necessary to take out loans you have to repay in order to achieve your business goals. Loans can provide you with the finances to acquire the labor and materials you need to run your business. Paying off the loans you take out can keep your business credit score in a desirable range. Doing so can also help increase the business' cash flow.

8. Create an efficient billing strategy

A large component of managing a small business' finances is managing cash flow as it relates to payment. It's important to ensure that the business operates in an efficient and timely manner every single day, and creating an efficient billing strategy to receive payment from customers can help contribute to this. Having a system that ensures clients pay you in a timely manner can ensure that the business have a positive cash flow when appropriate. Using a billing strategy that allows for this can lead you to financial success.

9. Review your books

Allotting time to carefully review your accounting and financial records, or books, can help you become familiar with the business' financial situation. If you have a bookkeeper who manages this information, consider reviewing their work once a week and discussing each entry with them. If you complete your own books, review them once a week and consider getting audits throughout the year to ensure accuracy and legal compliance.

10. Establish internal financial protocols

Implementing a few internal controls can help you stay familiar with business finance processes and information. Establishing internal financial protocols can help you mitigate risk, stay up-to-date on the business' financial health and give you firsthand insight into any finance-related issues that may present themselves. These protocols may include reviewing financial information at a set time every week, for instance.

11. Consider return on investment (ROI)

Considering return on investment, or ROI, can help you gain insight into which expenditures are valuable and which aren't. Being aware of where the business spends money can help you maximize profits by focusing efforts only on items that return you more than you spent. Understanding which investments pay off can help you determine the ones in which to invest more finances.

12. Learn how to interpret business financial documents

There are three specific financial statements that encompass a small business financial report: an income statement, a cash flow statement and a balance sheet. An income statement is a summary of expenses, income and profits of a business. A balance sheet is a summary of the business' liabilities, assets and equity. A cash flow statement summarizes the length of time it takes the business to earn money back after spending it. Being able to interpret these documents is important to understanding business finance basics.

13. Invest in business insurance

Taking out insurance on a small business can help you in a time of emergency or particular risk. You may consider investing in general liability insurance, commercial auto insurance, hazard insurance, theft insurance, professional liability insurance or business interruption insurance. Contacting an insurance agent can help you determine which insurance policies may best protect the small business.