As a small business owner, prioritizing strategic financial management is one of the most important things you can do for your business.
But you likely started your business because you believe in the work you’re doing. Not because you’re a finance expert.
At Hutch, we recognize not everyone has a background in finance. Which is why we give our cohort companies a strong foundation of support on their financial journey. This happens over the course of 3 intensive financial management sessions throughout our 24-month program.
But we believe in empowering our entire community, not just those who can join our program.
Which is why our expert finance coach and Fearless CFO, Ryan Hemminger, recently hosted a virtual office hour. (Sign up for our newsletter to find out when we’re hosting our next expert office hour)
Now we’re sharing Ryan’s responses to attendee’s burning financial planning questions.
The strategic financial management journey.
When you first begin your financial planning journey, it can be hard to know where to start. And as your company grows, your financial strategy and planning needs will dramatically change.
“From a financial planning perspective,” says Ryan, “your company will go through distinct phases.” And in each, your company will need to prioritize and focus on different areas.
Phase 1: Inflows over outputs.
In the first stage of your business, your business’s inflows — which include all of the income your company generates through work — will be more important than your outflows.
By maintaining strong inflows, you’ll be able to keep your business afloat and eventually grow into phase two.
Phase 2: Budgeting.
During this stage, you’ll create a budget. You’ll then use your budget to think through what the next 12 to 18 months will look like. And you’ll strategize how you’ll measure your progress against that plan.
This budget will help you determine if your business is making enough money and ensure you’re on the right path.
Phase 3: Long-term forecasting.
During this phase, you’ll focus on your 5-10 year forecast.
As you’re undergoing this long-term forecasting, you’ll want to ask “where is the cash going to come from that will fuel your operations?” says Ryan. And, as you consider that question, you’ll want to focus on the return on investment (ROI) for the capital that you’ll bring into the company.
Cash flow: Your strategic financial management through-line.
As you go through each of the previous phases, one of the major through-lines that will be consistently important is cash flow.
This is because “cash flow, especially as a small business, is the lifeblood of your company,” says Ryan.
Essentially, cash flow is the moving of money in and out of your business.
Dealing with slow-to-pay primes.
Being a government contractor means you’re likely going to work with primes who will be slow to pay you. Pay schedules are different for all primes.
And, considering how tight margins can be for small businesses, a late payment can negatively impact your business.
Start a conversation.
The first thing Ryan recommends when your prime is slow to pay, is talking to them.
“Look at your cash flow,” says Ryan. “From there, talk to your prime and let them know where you stand.”
Letting them know that you have cash flow challenges, and that you don’t have access to the same debt facilities that they might, could lead to quicker payments.
Some primes, like Fearless, will work with you. But with larger primes, you’ll have less ability to influence their payments and contracts.
Be diligent in your planning.
When you’re unable to influence your prime’s payment schedule, you’ll have to be more diligent in your planning.
You’ll also need to ensure that you have a credit facility that will support the delays in payment. This will likely mean that, when you get a line of credit from the bank, you’ll want to ask them for “a big enough line to support you in the event you don’t get paid for 30, 60, or 90 days,” says Ryan.
Staying on top of your planning and thinking ahead when you get a line of credit will help offset some of the issues that arise when a prime is slow to pay.
Getting and using loans.
One of the most important aspects of running a small business — and the strategic financial management that goes with it — is getting the capital to ensure you can keep it running.
And one way to get capital is by acquiring loans.
Knowing the information banks will need, and how you can use your loan strategically, will help you have a much smoother loan process.
Getting a business loan.
Figuring out what you need to do to secure a loan can be complicated.
After all, loans help ensure your business has the money it needs to thrive. But if you’ve never gotten a business loan before, it can be hard to know where to start.
1. Get your credit in order.
When you’re preparing to take out a loan, it’s important to remember that your bank account isn’t your business’s bank account. This means you’ll need to create a separate business bank account and credit card if you haven’t already.
This is important, because getting your business’s credit in order — and establishing your credit history — is the first thing you need to do before taking out a loan.
Use the credit card as much as you can — though you can’t use it for everything — and then pay it off every month to establish your business’s credit history.
2. Get your financial statements.
Once your credit is in order, you’ll need to have financial statements that you can show to the bank or lender.
There are a variety of tools you can use to put these statements together. But, according to Ryan, QuickBooks is the easiest to use and therefore usually the best option when you’re starting out.
Whatever tool you choose, use it to get your company’s financial statements, income statements, and balance sheets. Which are all documents that your bank will need to approve your loan.
Once you have these, the bank will look at your statements, along with your cash flow forecast and your credit history to determine whether they’ll loan to you and how much.
3. Take the number they offer, then renegotiate in a year.
Finally, after the bank has reviewed your information and offered you a loan, Ryan recommends you take whatever amount they’re willing to give you. Even though it will likely be a small loan, you just need to ensure it’s sustainable for the next 12 months.
After the 12 months are over, you can go back to your banker and ask them for a bigger loan. And then do that again every year to steadily increase the amount you’re borrowing.
Using the loan strategically.
Now that you’ve secured a loan and you’re further along with your strategic financial management journey, you might be wondering what to use the money for.
And if you ask 100 CFOs this question, you’ll get 100 different answers.
But Ryan’s general rule of thumb is:
“You want to have at least enough money to cover two pay periods — either in your bank account or through a line of credit.” Because you don’t want to be in a position where an accounting error leads to layoffs.
So, while it might be tempting to use the entirety of the loan to reinvest in your business, remember to save enough to ensure your company can keep functioning even in an emergency situation.
Calculate the ROI to determine how to use your loan.
But what should you do with your loan once you’ve set aside enough to cover two pay periods?
While this is a complicated question, the answer will come down to knowing what your ROI is going to be.
This means that, before making an investment, you’ll need to take the time to understand what your expected outcome is. And then, if you get a different outcome, what you’re going to do about it.
“You’re not in the business of throwing money at problems, or even throwing money at potential wins,” says Ryan. “You have to commit to making the investment that your company can afford.”
Understanding the ROI of using your loan will help you determine which investments your company can actually afford.
Bringing in investors.
Not every business will want or need investors. And the type of business you own will determine when you should seek out investors, if you plan to do so.
When it comes to bringing on investors,
- Product companies generally need them earlier. And they’ll likely use the capital from investors to expand production or distribution.
- Services companies will be less likely to need capital early on. Instead, they’ll seek out investors when they’re ready for expansion.
But whether you’re a product or a services company, you should think through your business goals before you bring on investors.
Some organizations, like Fearless, decide that investors don’t fit in with the future they’re envisioning and their strategic financial management journey. Instead, they look at debt vehicles as an alternative.
Debt vehicles can be preferable to investors for a variety of reasons. Whether you’re interested in:
- Keeping your equity intact,
- Waiting to bring on investors until your company is more established,
- Or taking advantage of low interest loans sponsored by the federal government.
Keeping your options open — and remembering that there are alternative solutions that offer the same outcomes as investors — will help you make the best decision for your company.
With all this said, even if you decide against getting investors at this stage, you might want to work with some in the future.
If and when you’re ready to do so, the information investors are looking for will depend on if you’re working with equity or debt investors.
Equity investors financially back your company, and in exchange they receive a stake in the business.
An equity investor will look at your company’s:
- Profit and loss (P&L) forecast: They’ll specifically focus on your EBITA, which will determine your company’s value.
- Balance sheet: This will help them ensure that there isn’t anything of concern around your debt or liabilities.
- Overall forecast: This will help them calculate their ROI.
An equity investors’ goal will likely be to grow your company to a certain point before finding a larger private equity firm that will buy them out and invest in you. Which means their priority will be to calculate how fast they’ll make a profit after investing in your company.
Unlike equity investors, who get a stake in your company in exchange for financial backing, working with debt investors involves borrowing money directly.
And while equity investors focus on your business’ overall forecast to get a sense of their ROI, debt investors want to know if you’ll be able to pay back their loan.
Because of this, they’ll look at your company’s:
- Cash flow,
- Income statements,
- Balance sheet.
These will help them determine whether you have enough free cash flow to cover their debt services.
Using your goals to determine what to do with your profits.
Knowing how much money you should reinvest in your business, and how much you should take out as profit, is an important aspect of strategic financial management. But it’s also a difficult decision to make. And the option you choose will depend on what your goals are as an entrepreneur.
For example, you might want to hit a specific benchmark and then maintain that size until you’re ready to leave the company. When that’s the case, you might be able to take a lot of the profit out of the company.
Or, your goal might be more impact focused. And in that case, if you take all the money out in profit, you won’t have enough resources to make an impact through your work.
And if you understand your goals, but you’re still wondering how you’ll know when you’ve made enough profit or generated enough wealth, Ryan recommends asking an advisor.
Whether you’re thinking of one day retiring as a business owner, or you hope to eventually sell your company, you should get an advisor who will work through the entirety of your financial plan. And who will help you understand how to get to the outcome you want.
Expanding your team.
When you’re looking to expand your workforce, the first thing you’ll want to do is make sure you can afford another employee. Which will require you to look at your cash flow.
But if, after looking at your cash flow, you realize you can’t afford to bring someone on, there are other options.
For example, you can “bring in a 1099,” says Ryan. “Or, if they have their own company, subcontract them. That way you can better manage your payment schedule and your cash flow.”
This sort of financial decision making, especially early in your company’s strategic financial management journey, will be critical to your long-term success.
Bring on employees when you can actually afford it.
If you find that you can’t afford to bring on an employee, it might be tempting to offer equity as an alternative form of compensation.
But, Ryan says that’s a big mistake a lot of early entrepreneurs make.
After all, you don’t want to be in a position where you bring someone on, give them a stake in your company, and then they decide to move on. Because then you’ll be expected to do all the work alone, while missing out on a portion of your company.
So, while offering equity might seem like a viable solution, it’s better to protect your equity and save it for when you really need it.
Wait for the right time to invest in a CFO.
Although a CFO is a valuable executive and team member, Ryan recommends small businesses should take their time before investing in one.
This is because a CFO is going to add a layer of administration a smaller organization can’t afford. And, when you’re smaller, you likely don’t need the kind of in-depth financial planning a CFO can offer.
Before getting a CFO, there are other options for financial experts you can utilize:
- Bookkeepers — You likely won’t need a bookkeeper permanently on-staff when you first start your company. Instead, you should outsource this work. Eventually, when you get a few million dollars in revenue, you can consider bringing on a part-time bookkeeper.
- Accountants — An accountant is always necessary. And if you don’t have one, you’ll want to get one. “Don’t file your own taxes,” says Ryan. “I can’t stress enough that you should be paying someone to file them for you. It’s money well spent.”
- DCAA advisors — If you’re in government contracting, you might also want to consider getting an advisor who can help you with your DCAA compliance. And will help you ensure your filings are in order. Like the bookkeeper, this advisor should be outsourced.
And if you don’t have any of these people on your team, then you’re not ready for a CFO.
But eventually, you’ll want to bring on a CFO. And Ryan recommends you do so just before you start to grow dramatically.
A CFO will be most valuable at this point because they’ll be able to:
- Help you develop your growth plan,
- Give you pushback on whether or not that growth plan is reasonable,
- Understand if you’re making reasonable decisions along the way.
By waiting to bring on a CFO until your company is actually ready for them, you’ll be able to take full advantage of their expertise, while saving your company money.
Get more strategic financial management tips from Ryan.
Whether you’re a new company or a seasoned business looking to expand, strategic financial planning will be critical to your success.
But knowing where to start can be hard.