3 Critical Financial Planning Tips Every Business Owner Should Know

By Joshua and Zachary Mersberger, Regional Directors, Merit Financial Advisors

The entrepreneurial world continues to grow; indeed, recent statistics show there are 31 million entrepreneurs in the United States, or 16 percent of the adult workforce. While the ability to pursue your passion, break free from the traditional confines of the modern workplace, or just enjoy more flexibility are enticing, it’s clear that few entrepreneurs are thinking ahead to their retirement. Research shows that while 70% of business owners think succession and exit strategy planning is important, only 15% of baby boomer business owners globally prepare for this transition.

Engaging early with professionals can help ensure that your business continues for generations, leaving a lasting legacy for your family or employees. Here are the top financial considerations small- and medium-sized business (SMB) owners need to consider.

1. Master Key Financial Terms

Understanding the language of finance is your first step towards making informed decisions that propel business growth. Here are a few key terms every business owner should familiarize themselves with:

  • EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization. A measure of profitability that shows how much money your business makes from its core operations, excluding the costs of loans and taxes.
  • Net Income: The true bottom line, indicating what remains after all expenses and taxes have been subtracted from revenues.
  • EBOC: Earnings Before Owners Compensation. This is crucial for family-owned businesses where personal and business finances often intermingle. It shows the business’s profitability before the owner takes their cut.
  • Cash Flow Measures: Including free cash flow (FCF) and operating cash flow (OCF), these metrics show how well your business is converting sales into cash, which in turn, affects its valuation.

Understanding these terms not only helps you gauge your business’s health but also informs decisions to enhance its value. Remember, focusing solely on top-line revenue might be misleading if the bottom line is not healthy.

2. Know Your Business Valuation

A shocking number of  business owners (98 percent, according to one report) have no clear idea of what their business is actually worth. This knowledge gap can lead to missed opportunities or undervaluing your business in a sale. Here’s why an annual business valuation is essential:

  • Strategic Decision-Making: Understanding your business’s valuation allows you to make informed decisions about growth opportunities and operational improvements.
  • Preparation for Sale: Knowing your business’s worth and the factors that influence it can help you prepare for a future sale, ensuring you get the best possible outcome.
  • Tax Planning: A valuation provides insights into potential tax implications of selling your business, allowing for more effective tax planning and strategy.

While getting a certified valuation might be costly, partnering with a financial advisor that specializes in working with SMBs can provide cost-effective alternatives that give you the insight needed for strategic planning. At Merit, we can create an initial valuation in a relatively short time by using a series of data and interviewing the business owner. This can easily be updated on an annual basis.

3. Early Succession Planning

The topic of succession planning often takes a backseat in the day-to-day running of a small business, yet its importance cannot be overstated. Succession planning should ideally start five to ten years before you plan to exit the business. Here’s why:

  • Smooth Transition: Early planning helps ease the transition process. Whether you’re passing the business to a family member or selling it, there are many considerations that come into play during this process, including internal and external communications, changes to operations and team structure, and more. 
  • Maximize Value: By planning ahead, you can take steps to increase the value of your business, making it more attractive to buyers.
  • Prepare Financially: Understanding what you need from the sale to retire comfortably allows for targeted financial planning and strategies.

Final Thoughts

Financial planning is as crucial as any other part of running a business. By understanding key economic terms, consistently evaluating your business valuation, and planning your succession early, you’re not just surviving; you’re setting the stage for sustained growth, generational wealth, and legacy building.

Remember, selling a business will always take longer than you think. The United States is still in a historically low tax environment, but tax policy could be changing soon under a new administration. If you’re considering selling your business in the next year, it would be wise to connect with your financial planning professional sooner than later.

Navigating the complex landscape of business finance can be daunting, but you don’t have to go it alone. Building a team of qualified advisors can provide the guidance and insight needed to make strategic decisions with confidence. Remember, the goal is not just to run a business but to build a valuable asset that serves you long into the future.

Working with a financial advisor is paramount for business owners. Curious about your business’ valuation or have questions about how to approach the sale? Contact Merit Financial Advisors today for a complimentary consultation.

Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Merit Financial Group, LLC, an SEC registered investment adviser. Merit Financial Group, LLC and Merit Financial Advisors are separate entities from LPL Financial.