Business Finance Strategy Frequently Asked Questions (FAQ)

In this installment of our frequently asked questions, we demystify questions our CFOs get on the regular about business strategy and business finance.

What financial metrics should we focus on as a business and how do we track them?
—Saxby Morehead

When running a small business, focusing on key financial metrics is crucial for maintaining financial health and ensuring growth. Here are the top two financial metrics to focus on and how to track them:

1. Gross Profit Margin: The percentage of revenue that exceeds the cost of goods sold (COGS). It is calculated as:

   (Revenue – COGS) ÷ (Revenue x 100)

   Tracking: Ensure accurate recording of sales and COGS in your accounting system. Review gross profit monthly to assess the profitability of your core operations. Target or desired Gross Margin varies by industry so determining which percentage is the right margin for a specific business is a different topic for another FAQ article!

2. Cash Flow: The net amount of cash being transferred into and out of the business. Positive cash flow indicates that a company’s liquid assets are increasing.

   Tracking: Use cash flow statements to track inflows and outflows. Cash flow management tools or accounting software can help in projecting future cash flow and identifying potential shortfalls. Think of cash as the lifeblood in a business. Tan skin, white teeth, muscles, etc. don’t mean much if you bleed out. Same with your website, office space, product if the business can’t pay vendors or meet payroll. We have seen profitable businesses go bankrupt because they simply run out of cash.

What is the advantage of taking a W-2 salary vs. a guaranteed payment if you are a principal member of an S-Corp?
—Lauren McGuire

Taking a W-2 salary as a principal member of an S-Corp has several advantages over receiving guaranteed payments of an LLC:

Tax Benefits: W-2 wages are subject to payroll taxes (Social Security and Medicare totaling 15.3%), but an owner can avoid the self-employment tax that applies to guaranteed payments received by partners in a partnership or LLC members. Instead of all the guaranteed payment being subject to the payroll tax, in an S-Corp a business owner only has to pay themselves a “reasonable” salary. So if a business owner received a guaranteed payment of $160,000 from a business for services, it all would be subject to self-employment tax. But if that same business was an S-Corp and received the 160K, it would be up to the owner to determine his or her salary. If a salary of $120,000 is reasonable, the remaining 40K of income would NOT be subject to this additional layer of tax; the owner would simply pay income tax on it but not the payroll taxes (Social Security and Medicare).

Employee Benefits: As a W-2 employee, you may be eligible for employee benefits such as health insurance, retirement plans (e.g., 401(k)), and other fringe benefits that can be more advantageous than those available through guaranteed payments.

Enhanced Credibility: Drawing a salary as an employee can enhance your credibility with lenders and investors, as it demonstrates a more traditional and stable business structure, plus everyone knows what a W-2 is.

How do you calculate the amount of revenue replacement I need on my business insurance policy in case of a disruption?
—Jason Alexander

This question is timely because one of my clients was recently affected by a fire. No one was injured and damage was minimal but it’s going to require significant repairs, and they will be closed for a significant period.

First start by calculating monthly/annual expenses such as rent, utilities, salaries, and loan payments. Be sure to include variable costs like inventory, supplies, and marketing. Make sure to plan for a contingency fund to cover unexpected expenses or downturns. A major decision will be how long to do revenue replacement for. Consider if revenue replacement will be needed until normal operations resume or is it needed for only a fixed period. Consulting with an insurance professional can help ensure accurate and comprehensive estimates for this very valuable insurance.

Why should I create a budget and forecast?
—John Illges

Budgeting and forecasting are essential to helping business owners evaluate their financial performance and ensure they are tracking toward their long-term goals.

A budget is a fixed plan of expected outcomes for a specific period. The goal of a budget is to use historical data to set financial targets, limit spending, and create a resource plan for the coming year.

A forecast is a more dynamic and involved process. A good forecasting model will allow a business owner or CFO to update assumptions and projections in real-time to effectively track overall business performance or the success of a particular project. Forecasting allows adaptability as a business and gives business owners the opportunity to make informed strategic decisions.

Budgeting and forecasting are vital tools that anyone can use to make informed decisions and bring both stability and better forward-looking visibility to their business.