Starting a business is a dream for many entrepreneurs, but the road to success is filled with challenges. According to Bloomberg, 8 out of 10 entrepreneurs who start businesses fail within the first 18 months.
According to the U.S. Bureau of Labor Statistics (BLS), approximately 20% of new businesses fail during the first two years, and the failure rate increases to 45% within five years. Shockingly, only 25% of new businesses make it to 15 years or more. These statistics have remained consistent since the 1990s.
What is Business Financial Literacy?
Business financial literacy refers to the knowledge and understanding of financial concepts and practices relevant to operating and managing a business. It involves the ability to comprehend financial statements, interpret key financial ratios, make informed financial decisions, and navigate the financial aspects of running a business effectively.
Key components of business financial literacy include:
Financial Statements: Understanding and analyzing financial statements, including the income statement, balance sheet, and cash flow statement. This involves interpreting the financial health and performance of a business based on these statements.
The 3 Statement Financial Model
Budgeting and Forecasting: Creating and managing budgets to plan and allocate resources effectively. Business financial literacy includes the ability to forecast future financial scenarios, helping businesses prepare for potential challenges and opportunities.
Cash Flow Management: Effectively managing cash inflows and outflows to ensure the business has enough liquidity to meet its short-term obligations. This involves monitoring and optimizing the timing of cash transactions.
Financial Ratios: Interpreting and using financial ratios to assess the financial health and performance of a business. Ratios such as liquidity ratios, profitability ratios, and leverage ratios provide insights into different aspects of a business’s financial position.
Tax Planning: Understanding the tax implications of business decisions and implementing strategies to minimize tax liabilities within the legal framework. This includes knowledge of tax deductions, credits, and compliance requirements.
Investment Decisions: Evaluating investment opportunities and making informed decisions regarding capital expenditures, expansion projects, and other financial investments that align with the business’s strategic goals.
Debt Management: Understanding the impact of debt on the business and making informed decisions about taking on or repaying debt. This includes managing interest payments and assessing the overall debt capacity of the business.
Risk Management: Identifying and managing financial risks that may impact the business, including market risks, credit risks, and operational risks. This involves implementing strategies to mitigate the potential negative effects of these risks.
Financial Decision-Making: Making strategic financial decisions that align with the overall business strategy. This may include pricing strategies, product development decisions, and capital structure decisions.
Why Business Financial Literacy is Important
Financial literacy is a crucial factor that gives warning signs about factors that can make or break a business. A solid and realistic business plan is essential for success. It helps outline achievable goals, identify the need for the business, assess costs and inputs, and establish strategies and timelines. A key component of the business plan is the financial forecast or projections and deviating from the business plan or not following it consistently can lead to failure.
The forecasted and actual financial numbers (income statement, balance sheet and cashflow) give early warning signs that something is fundamentally wrong with the business in all these instances, however it is only entrepreneurs that understand financial numbers that can recognize the signals and then take action to address the problems.
Insufficient financing is a big reason for business failure. Many entrepreneurs start with too little capital, making it difficult to sustain the business until it becomes profitable. It is crucial to plan for enough funding to cover expenses until positive cash flow is generated.
Expanding too fast without sufficient cashflow to fund operations can be detrimental to a business. Growth should be approached with the same care and attention as when starting the business, ensuring a thorough understanding of new markets and products.
Thus, financial literacy is crucial for entrepreneurs to make informed decisions and effectively manage their business finances. Understanding numbers, financial models, and projections allows entrepreneurs to make strategic choices that contribute to business success. To improve their understanding and confidence in dealing with financial matters, entrepreneurs should consider seeking business training that emphasizes financial literacy.
In summary, financial literacy is a critical component of business success. Entrepreneurs who understand numbers, financial models, and projections are better equipped to navigate the challenges that arise when starting and running a business. By recognizing the common pitfalls and seeking business training that emphasizes financial literacy, entrepreneurs can increase their chances of building a successful and sustainable business.
Source Links
- https://www.investopedia.com/financial-edge/1010/top-6-reasons-new-businesses-fail.aspx
- https://www.forbes.com/sites/ericwagner/2013/09/12/five-reasons-8-out-of-10-businesses-fail/?sh=7835d86a6978
- https://www.luisazhou.com/blog/businesses-that-fail/
