At the beginning of every new business is the vision of blue skies – before some small business owners fall into common financial mistakes. Too often, small business owners get caught up in the idea of starting a new venture that they begin to neglect financial issues that could have a fatal affect on the business.
Here are 10 warning signs for small business owners to make note of and avoid at all costs. Literally. If not, those blue skies can turn gray and the exciting new business venture will quickly become a burden.
One of the biggest mistakes new businesses make is not having enough capital to support a new venture. Insufficient funds can not only doom the business, but it could also put personal assets in jeopardy. Before launching a business, it is best to ensure enough cash is on hand until customers start paying their invoices.
There is a difference between the promise of revenue and actually depositing those funds into the bank. Hiring employees based on anticipated contracts is not a good idea. Until revenue is in the business bank account, it does not exist. Being optimistic is good to withstand the unexpected, external forces that can negatively impact a business. It encourages resilience. However, it does not work when reality calls for paying employees on time.
Likewise, hiring too much overhead: people who cost money, but fill non-revenue generating roles. Employees who sell products or services, provide customer service or build products are typically considered revenue generating roles. Keep the former group count as low as possible.
Another financial mistake small business owners make is borrowing money that is not needed even though the bank is willing to grant a loan. Banks are in the business of collecting interest; optimizing the financial performance of a small business is secondary to their profit goals. Of course, a profitable business guarantees the bank will get paid, but that does not mean that the business owner should accept the loan.
Generally, small business owners should only borrow what is needed to grow the company. Too much credit can cause bigger financial problems and make it unavailable when it is really needed.
Making wildly optimist forecasts of future sales leads to poor business planning. Surviving this mistake requires having detailed financial estimates that include pricing strategies from realistic numbers and expectations. Analyzing the target market and knowing what competitors are doing will bring good forecasting into focus.
When in doubt, it is best to underestimate sales projections and overestimate expenses. In addition to pricing strategies, small business owners – or their finance expert – should calculate fixed costs, variable costs and cash flow planning.
Not paying payroll taxes on time can lead to penalties and interest that quickly diminishes profits. Essentially, small business owners act as a collection agent for taxing authorities. They are responsible for deducting federal and state taxes from employees and remitting the money to the proper tax authority.
The problem occurs when payroll liability amounts are not set aside when payroll checks are cut. These amounts should be deposited into an operating account that is separate from the business expense account. Otherwise, funds get mingled and there is an inflated assumption of the cash balance.
Typically, the small business owner is not being dishonest about withholding tax revenue; it is simply easy to lose track if doing so is not part of standard financial practices. Trying to play catch-up later causes taxes to accrue, leading to severe penalties and interest. Rarely is there enough cash available to satisfy the tax bill in a timely manner.
No small business owner should ever think ignorance is a blissful trait in running a successful business. Failing to keep accurate and timely records will lead to serious problems that are easily overlooked. It is too late to realize records were inaccurate when the SEC or IRS is knocking at the door. Good accounting records show what is right and wrong. These records will also alert owners to potential pitfalls.
Unless the business is a national chain with aspiring goals to eventually have multiple locations, it is best to sell fewer products at higher prices than sell more products at low prices. Pricing products at a high level helps to protect profit margins and in some cases, the business brand. Even a small increase of 10 percent can make a significant difference to the bottom line.
Typically, approximately 30 percent of small businesses in any given industry cannot be profitable at current product prices. In many ways, the small business owner has setup a nonprofit organization, except the financial obligations are for-profit. Industry research on pricing is essential to setting prices at or near the average price that the market can bear. Even a slightly higher price is possible for many products.
The tendency to price products too low at the start of a business is very common. It is best, however, for small business owners to invest the necessary time into developing a real product differentiator. Waiting for prices to do this devalues the product and some customers will automatically go to the competitor if they believe quality is reflected in the price.
Offering generous credit terms just to get the business does not help when a business provides services and customers do not pay. Unless it is necessary for the business model, some small business owners should be hesitant about offering credit to customers. More often than not, small businesses fail because they are unable to collect receivables.
Credit should be offered only when it is economically feasible and in the best interest of the small business. For instance, landing a major business-to-business contract with a reputable organization might prove beneficial to having a long-term partnership.
Depending on one major source for revenues is not good financial management for any business, particularly small businesses. Similar to not hiring employees based on a promised contract, small business owners should never rest in the comfort of one revenue stream. It is best to assume that such revenue is not available. Owners should proactively build revenue from other sources.
A good practice is to view revenue as a portfolio; all or a majority of revenue should come from multiple sources. Even in the beginning stages, small business owners cannot neglect two things: serving the first few loyal customers and actively pursuing more accounts. Building alternative sources of revenue is important to surviving when a major stream dies off.
Failing to manage cash flow properly is another common reason many small businesses fail. In some cases, poor cash flow management is the result of extending too much credit and failing to collect on invoices. In other cases, the small business owner simply started the business without strong financial practices in place.
Another failing of poor cash flow are due to excessive inventory in addition to poor credit policies and poorly managed accounts receivable. In a short period of time, a small business that is otherwise viable can end up in bankruptcy court.
Small business ventures are fraught with mistakes and missteps, even in the financial department. Even seasoned business owners can run into a problem at some point during the lifecycle of the business.
The key to remaining successful is to identify any mistakes as quickly as possible, learn the lesson and put solid policies in place to avoid repeating the same mistakes. Doing so can mean the difference between having a successfully viable business and one that is just a money pit of financial agony for many years to come.