The Financial Literacy Basics Entrepreneurs Need to Know Use these core pillars to understand, use and manage risk with our money.
By Derek Notman •
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Like most of you, I grew up with virtually no formal training on money. I learned that we definitely need money to get the things we want and one way or another, we have to work for it. Short of getting my passbook savings account back in the '80s, I was taught very little about how to be financially literate.
What happened? I got a job, paid bills, saved a little (but not really) — and then, when I got to college, I went into credit card debt in exchange for a free T-shirt. By not getting the proper education on money, it controlled me instead of the other way around. We all know how that feels! But it doesn't have to be this way. Financial literacy won't happen by accident; it happens by design.
Money, for most of us, can be a double-edged sword. Some days we are in love with making it, some days we dread having to work to get it. As a dad, CFP and fintech entrepreneur, I've learned that a high level of financial literacy is key to one's success. To have a great relationship with money, we must understand what it is, how to use it and how to manage our risks when we use it — so here's what you need to know.
Understanding money
Money is a tool. It helps us accomplish what we want and need in life and business. We all have a relationship with money, and how it manifests itself through our spending is based upon our financial literacy — or lack thereof.
The first step for increased financial literacy is to understand that money is a tool created out of an idea and need for us to exchange things of value, be it goods, services, etc. You don't want more money — you want more of what it does for you.
So how do you understand money? Understand how you spend it by mastering your cash flow. Show me how and where you spend your money and I can tell you if you understand it or not and what's important to you. Knowing your cash flow helps you understand what you actually do with your money which can be very insightful and helpful on how best to use your money. I didn't understand money or my cash flow at all after graduating college, but I eventually mastered it by creating and using a simple yet robust cash flow worksheet. This will help you learn how to properly use money.
Using money
Money should be thought of as a tool of precision that can help us accomplish whatever it is we want. We earn money by doing or creating something of value. But what are you using your earned money for? Once you understand your current cash flow situation, you can assess some simple yet important things. Are you cash flow positive every month? If not, why? Are you spending (using) money on mainly assets or expenses? Assets ultimately put money in your pocket, while liabilities (expenses) take money out.
Once you understand your money and where it's currently going, you can leverage this information into how best to use your money. Instead of spending X dollars a month on coffee every morning, which can easily add up over time, what if you took that money and used it on something that made you money? You could spend it on marketing your business, investing in a savings plan, paying down debt and so on.
Taking it a step further, you can now determine the ROI on where you're using your money. If you're paying down debt faster with your excess cash flow, you're saving interest — and that's real money. Investing your excess cash flow into marketing your business and seeing increased sales because of it? Now you have a direct correlation with what happens when you understand and use your money.
A best practice is to balance how you use your money. There's nothing wrong with spending some of your money on things that you want, but it also makes sense to deploy your money into things that can work for you. Where will your money work hardest and best for you?
Related: We Owe it to Consumers to Foster Financial Literacy
Managing risk with money
Virtually everything in life has some level of risk. Risk is basically uncertainty about the future. When it comes to our finances, whether it's personal or business, we have an opportunity to protect ourselves against uncertainty and manage risk. As an entrepreneur, we are prone to and arguably seek out risk since we know it can lead to a lot of rewards, but that doesn't mean that we should blindly take on risks and just hope for the best. Planning for the worst and hoping for the best is a sound practice to help manage your risk.
Some simple guidelines to manage risk with your money are:
- Spend less than you make (positive cash flow).
- Keep a solid cash cushion liquid in case of emergency; somewhere between 6-12 months of your expenses from your cash flow worksheet.
- Consider appropriate types of insurance to protect against large but unlikely risks like death, accident, illness, security, etc.
- Don't invest all your capital into one thing, and with any investment you do make, ask yourself first, "What happens if I lose every penny of this investment?" If you don't like or can't live with the answer, then it's probably too much risk for you.
If we know what money is, how to use it and how to manage risk with it, we end up empowering ourselves to be the master of not only our money but — to an extent — our future. Life happens and curveballs will fly, but controlling these variables to the extent we can gives us a much better chance of being successful with our money.
