Like many business owners and entrepreneurs, you most likely started a company because you saw a market need or problem and were armed with the passion and expertise to meet that need.
However, many of the most common financial mistakes happen early on in a business when time and resources (i.e., cash flow) are particularly tight. You might be determined to overcome obstacles yourself and learn things on the fly, and though this approach sometimes works, it may cost you in the long run.
Business growth can also expose and exacerbate infrastructure problems because it’s a careful balancing act between hiring talent, investing to increase efficiencies, and supporting increased expenses with additional sales. Putting too many resources in one over the others can bring the business down. The answer? Plan financially as much as you can, and be aware of the most prevalent mistakes business owners make when it comes to money.
Common Mistakes Business Owners Make with Their Finances
Hopefully, you have experience creating a personal budget—managing known expenses like your rent or mortgage and unforeseen expenses like car repairs that pop up from time to time. With your personal budget, the more you can forecast and prepare for the worst, the better off you will be.
The same is true for financial planning for business owners. And although some things will change the minute after you make a plan, a forecast will help you keep balanced books and set yourself up for success. As you build your business financial plan, you should also keep in mind some of the most common mistakes business owners make with their finances.
If you see any of these in your own organization, a swift correction should be your top priority.
1. Failure to plan for worst-case scenarios
You never want to think about how your family would cope if something should happen to you, but as a business owner, it is critical to have estate documents that include your will, powers of attorney, health care documents and possibly a trust. All your assets should have the appropriate titling and beneficiaries, and you should have adequate life insurance and disability insurance, as well as an emergency fund in place should you become ill, incapacitated or worse.
Your business is a large part of your life, so you’ll also want to plan for a worst-case scenario from a business perspective. Make a business continuity plan that covers where to find important documents; a list of individuals like accountants, attorneys, and customers to notify; and other things that would be helpful for a successful transfer of ownership to your beneficiaries. Although estate planning is not something most people like to dwell on, it ensures your business is taken care of—the way you want it to be—after you’re gone.
2. Lack of understanding of how to manage cash flow and working capital
Business owners often focus on generating sales but still find themselves tight on cash. Managing accounts receivable (AR) is one of the most important aspects of having a successful business. Before opening your doors for the first time, get an idea of the average AR benchmarks for your industry. This information will help you decide how to manage cash flow. Working with vendors who have extended terms—that potentially align better with your AR timelines—can also help.
Because business growth requires capital in order to support payroll, AR, inventory and more, it is a good idea to establish cash flow forecasting models. These estimates are generally prepared every week and project expected inflows and outflows over a 90-day period. This helps determine whether a working line of credit could be useful to establish or whether finding other sources of working capital would be beneficial.
3. Failure to mitigate risk
Plenty of businesses struggle or fail due to both predictable and unforeseen losses. To help mitigate these, have an insurance professional help you evaluate the different types of exposure you have and determine what can reasonably be covered by insurance. For losses that cannot be insured or cannot be insured on a cost-effective basis, you should decide how best to protect against the possibility of a financial loss.
Extending credit to a customer, for example, opens up the potential for nonpayment, so decide whether it’s a good idea. If it’s necessary, you’ll have to then decide how credit will be approved and monitored. From an employee standpoint, put processes in place to reduce the risk of being taken advantage of. Give prepaid gas cards, for example, instead of company credit cards for gas. Monitor expense accounts and let employees know they are monitored to ensure your finances are in a good place. When dealing with people, it’s always a good idea to “trust but verify.”
4. Trying to go it alone
Business owners are often independent, driven problem solvers. It’s a great recipe for starting a business, but it can also lead you to try to do everything on your own, including tasks that you aren’t necessarily well-suited to perform.
If you’re a creative, right-brain thinker, for example, you might be a passionate product designer or marketer. The analytical, numbers-based side of the business may not come naturally to you. This can lead you to getting bogged down with numbers. Finding someone to look after items like payroll and AR in addition to your retirement fund, whether it’s a SEP IRA, SIMPLE IRA, or solo 401(k), can be extremely beneficial for both your peace of mind and bottom line.
Start with an honest assessment of both the areas you excel at and any shortcomings you might have. With an accurate picture of your capabilities, work to assemble a team that complements you and plugs any gaps. An advisory board can also be helpful to spot new ways of doing things, challenge the status quo, and create efficiencies in the business.
Running a business is a difficult endeavor, and you can’t expect to get everything right all the time. However, although you can easily recover from certain errors in judgment, some common financial mistakes can quickly ruin a business if left unchecked. As you work to protect your own organization so you can keep your doors open for years to come, prioritize financial well-being and quickly rectify any of the mistakes mentioned above.
Disclosure: This material has been prepared for informational purposes only and should not be used as investment, tax, legal, or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal, and accounting advisors.
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