How important is financial literacy to small business owners?
Financial literacy means understanding how money works, such as managing, saving, investing, and spending it wisely — in other words, a financial education you need to have. As a small business owner, you must know where your money is coming from and where it is spent. In fact, nowadays, being financially literate is a must-have skill for business owners like you. And lacking this knowledge could result in poor decisions and, ultimately, business failure.
In Australia, only 66% of the population can be classified as financially literate, indicating a significant need for improvement, according to the University of Newcastle’s recent research study. This lack of financial literacy can have severe consequences for small business owners, who must make informed financial decisions to secure their business’s survival and growth despite the increasing inflation rate.
In this article, we will tackle the importance of a strong financial base for making wise choices that contribute to your business’s long-term success and how you can begin building your financial literacy without spending a fortune.
Learn the basics
It is true that knowledge is power, and this is especially relevant for small business owners. As Benjamin Franklin once said, “An investment in knowledge pays the best interest.” This quote highlights the importance of acquiring knowledge, especially financial literacy, for those running a small business. When small business owners are financially smart, they can steer clear of problems like overspending and bankruptcy.
Acquiring knowledge of finances or money may seem overwhelming, particularly if you are a beginner. However, need not fret, as there are several resources available to help you advance in financial literacy. The Australian Securities and Investments Commission (ASIC) and the Australian Taxation Office (ATO) offer free resources to help new business owners in starting their small businesses.
For example, ASIC’s “Running a Small Business in Australia – What You Need to Know” booklet provides an overview for those who plan to operate a small business as a registered company or under a registered business name. It may also be worthwhile to listen to the ATO’s podcast, Tax inVoice. Host David Jepsen and Assistant Commissioner of Small Business Experience Andrew Watson discuss tips for starting a new business, meeting tax and super obligations, and other useful resources for small business owners.
Get the right support
Financial literacy can make seeking help seem daunting at first. It is natural to want to avoid being judged. But, do not worry; there are plenty of options at your disposal, including finance brokers who offer legitimate, customised advice tailored to your specific needs.
Engaging a finance broker can be advantageous when you are looking to borrow money. Brokers can simplify the process by connecting you with multiple lenders, even those less well-known ones offering competitive rates. They can assist in determining the appropriate borrowing amount based on factors like your goals and budget. Additionally, they can guide you through the borrowing process, using their industry expertise and experience to deliver personalised advice.
Collaborating with a broker can also bring you peace of mind, as they are legally obligated to prioritise clients’ interests above financial institutions. They consistently review your circumstances to ensure your loan remains suitable for your current needs and can help with refinancing if needed. Brokers can also save you time and alleviate stress by managing the complex borrowing process for you. They can clarify industry terminology and offer guidance, enabling you to make well-informed decisions. In the end, working with a broker can help you secure the best loan without the burden of directly dealing with lenders.
Manage cash flow
Poor cash flow management can cause businesses to fail. Even if a business appears successful, it could still face problems with cash flow that can hinder growth potential. For example, a small copywriting agency may have to turn down a big project from a local government council because it cannot cover the expenses of producing content, and paying employees and subcontractors before the payment is received.
And where does poor cash flow management usually stem from? The answer is the lack of financial literacy. Data provided by the Australian Securities and Investments Commission indicates an increase in Australian corporate bankruptcy filings from 238 in February 2023 to 467 in March 2023 due to poor cash flow management. A recent study done by the University of Melbourne also discovered that 77% of Australians have financial regrets. The top three regrets revolve around insufficient attention to savings, investments, or budgeting while the fourth most common regret concerns a lack of financial literacy.
So, what can you do as a small business owner? You can start by building your savings, increasing revenue and lower expenses, opening a credit line, negotiating terms with suppliers, offering discounts to customers who pay early, or considering invoice financing or factoring. Take note that profit and cash flow are not the same, and you must manage your cash flow on a month-to-month basis.
As a small business owner, you need to understand the types of credit available to you, including loans, credit lines, and credit cards. At some point, you may need to borrow money to expand your business, and knowing the differences between these options can guide your financing needs — ensuring you are not taking on more debt than you can handle.
Begin by reviewing and prioritising your business liabilities, and considering the consequences of late payment. Next, implement a debt payment strategy, such as the debt avalanche or debt snowball methods, and delegate debt management tasks to your accounting team or an outside consultant if necessary.
Another way is checking loan terms for refinancing or restructuring options while focusing on increasing revenue. You may also try reducing business costs to maintain a healthy cash flow. Analyse your total and recurring expenses, then find ways to cut costs by a certain percentage. Use the freed-up funds to pay off your highest debt priorities. Lastly, conduct regular reviews for successful debt management.
Budget and forecast
As the famous entrepreneur Peter Drucker said, “You can’t manage what you don’t measure.” Budgeting and forecasting are essential for planning your business’s financial future, helping you avoid overspending and capitalise on opportunities.
Financial literacy is key in understanding the differences between budgeting and forecasting, as well as their respective roles in a small business’s financial planning. Budgeting involves creating a plan for the business’s financial performance over a specific period, while forecasting uses actual sales and cost data to predict future trends.
Being financially literate allows you to accurately develop budgets and forecasts, as well as compare them to identify discrepancies and adjust your strategies accordingly. Regularly monitoring and comparing budgets and forecasts also enables you to address potential issues or capitalise on emerging opportunities, ultimately improving your financial planning skills by allocating resources effectively.
One of the open secrets to building wealth is the decision to invest rather than just save. And financial literacy plays a big factor, as it is often found to be higher among the wealthy, educated, and those who actively use financial services.
By becoming financially literate, you have a strong financial background that you may use before investing. You start setting realistic saving goals and develop appropriate strategies to achieve them. A key part of this is your understanding of the importance of an emergency fund, setting aside money for your future expenses, and saving for long-term goals such as your retirement or education which sets the stage for your successful investing.
You then become more equipped to participate in investment activities and understand the implications of incurring debt, recognise the significance of credit scores, and maintain a manageable debt-to-income ratio. You can identify the potential risks and rewards related to different investment options and choose what works for you. Consequently, you can possess a more diversified investment portfolio and keep track of how well they are doing. Financial literacy can not only help you manage your business well but could also help you become wealthier in the long run.
In short, by becoming financially literate, you can set realistic goals, understand various financial aspects, and make reasonable decisions which leads to wiser financial choices, helping you achieve financial stability and growth. However, it’s worth noting that no man is an island. No small business owner achieves financial success in isolation. Partner with INK Financial Solutions, a finance/mortgage broker that specialises in finding funding solutions for individuals, families, and businesses. De-Arne O’Toole can assist you in staying on track and identifying the most suitable financial options for your needs. Contact INK Financial Solutions today to start crossing several items off your financial “to-do” list.