Running a small business is as challenging as it is rewarding, especially when it comes to financial management. As a business advisor, I’ve observed many common errors that can jeopardize a small business’s success. Here’s a breakdown of 20 of these pitfalls and practical advice on how to steer clear of them.
1. Maintain Accurate Financial Records
Accurate record-keeping is the foundation of sound financial management. Many small business owners overlook this, leading to complications with tax compliance and financial reporting. Implement robust systems for recording transactions and ensure you have effective financial controls in place.
2. Separate Personal and Business Finances
Mixing personal and business finances can create a maze of financial records. To avoid this, open separate accounts for your business and strictly use them for business transactions. Far too many small business owners burden their companies with a personal income the model cannot sustain. You shouldn’t be going into debt or cash-strapped because of your personal financial needs.
3. Forecast Cash Flow
A common oversight for many entrepreneurs is not having a clear understanding of cash flow. Prepare a cash flow forecast and update it regularly to reflect business changes. This will help you manage finances more effectively and plan for future needs. I advise looking for one week, six weeks, six months, and one year out with your projections. Please also understand that there is a difference between profit and cash.
4. Understand Cost of Goods Sold
Knowing the cost of goods sold is crucial for pricing and profitability. Identify all variable costs associated with your products or services and include a profit margin to ensure sustainable business operations. To the degree you can disaggregate this information into specific product/service line categories or geographical areas, the better.
5. Monitor Key Financial Metrics
Regularly tracking financial metrics is essential. Develop a dashboard that highlights key performance indicators (KPIs) affecting sales and profits, enabling you to make informed decisions. There are general business success metrics such as sales growth, profit, cash flow, sales pipeline, work backlog, etc. that are advisable across all companies, and they should be supplemented with any specific metrics relevant to your industry, e.g., billable hour utilization, sales per square foot, inventory turns, etc.
6. Seek Professional Financial Advice
Many small business owners hesitate to seek professional advice. Engaging with a financial advisor or accountant can significantly enhance your ability to navigate intricate financial environments and prevent costly errors. At least once a year, have your lead internal financial person, accounting firm partner, and personal finance advisor meet to review and discuss your financial plan. Keep your banking contact in the loop on all important financial developments and seek their advice as needed. Additionally, you can leverage the readily available fractional CFO expertise when needed. If you plan to exit within the next 3-5 years, start developing relationships with investment banking firms that specialize in M&A practices.
7. Manage Inventory Efficiently
Improper inventory management can lead to either excess inventory or stock shortages. Regularly review inventory levels and use inventory management systems to maintain the right stock levels. Inventory eats cash and takes up space. If it’s not moving, figure out “plan b.”
8. Control Expenses
Understanding and controlling expenses can significantly affect profitability. Rank your expenses based on their impact on your income statement and apply the Pareto Principle to focus on the most significant costs.
9. Develop a Clear Business Plan
A well-defined business plan is vital for making informed financial decisions. Outline your business goals, strategies, and financial projections in a formal plan. Plan your work and work your plan. Have metrics and milestones in place to gauge your progress and manage accordingly.
Relying on a single product or service can be a risky strategy. To safeguard against market fluctuations, diversify your offerings, and explore new markets. As a general guideline, I suggest that no single client or product/service should account for more than 15% of the total overall revenue.
11. Manage Debt Wisely
Excessive or poorly managed debt can strain your finances. Create a debt management plan that includes timely repayments and seek better terms for your debts. It’s also critical to understand the difference between short- and long-term debt and to use these two options appropriately. Having a good relationship with your banker can make a significant difference in this regard, ensuring you are in the right debt vehicles.
12. Plan for Taxes
Failing to plan for taxes can lead to financial strain. Work with a tax professional to develop a strategy and make estimated tax payments to spread out tax liabilities. I’ve witnessed numerous small businesses stumbling into financial difficulties when it comes to tax payments. Late payment penalties and interest payments can become pretty expensive if you are not careful.
13. Monitor Receivables
Monitor the accounts receivable closely and promptly pursue overdue payments. Implement penalties for late payments to discourage delinquency. It’s also important to pay attention to the days in accounts receivable relative to the days in accounts payable, ensuring you don’t create your own cash flow issues.
14. Invest in Your Business
Investing in technology, marketing, or training can enhance your business operations and promote growth. Understand which investments will generate revenue and prioritize them. Please ensure that a cost-benefit analysis is conducted and the return on investment (ROI) is calculated before proceeding.
15. Adapt to Market Changes
Stay informed about industry trends and be ready to adjust your business strategy to remain competitive and responsive to market demands. Being proactive in understanding customer, vendor, and competitor dynamics is preferable to being reactive.
16. Manage Risks Effectively
Identify potential business risks and develop strategies to mitigate them. Effective risk management can prevent financial losses and enhance business resilience. Most leaders have a reactive and poor understanding of the multitude of risks confronting their company.
17. Invest in Financial Management Systems
Relying on outdated systems or manual processes can hinder financial management. Consider adopting modern financial management software to streamline operations. The short-term pain of implementing a new system should be offset by improved reporting and forecasting capabilities, which will enable you to make more informed, real-time, data-driven decisions.
18. Understand Financial Reporting Requirements
To avoid legal issues, ensure compliance with financial reporting standards pertinent to your industry. Seek professional guidance to navigate complex regulations. Obviously. Some industries are more highly regulated than others, such as healthcare, education, and freight forwarding.
Unexpected events can disrupt business operations. Develop contingency plans and allocate funds to cover unforeseen expenses. Examine the primary drivers of your business’s success, particularly external factors, and run various scenarios to plan for contingencies and emerging trends.
20. Communicate with Stakeholders
Maintaining open lines of communication with stakeholders, such as vendors, customers, and strategic partners, is crucial for fostering mutual understanding and support. Regular updates can prevent misunderstandings and foster a supportive business environment. These relationships often involve price changes, which require tactful navigation, factual support, and appropriate business rationale.
Conclusion
By addressing these financial management mistakes, small business owners can improve their economic performance, mitigate risks, and lay the groundwork for sustained success. Regularly review your financial practices and seek professional advice to ensure you’re making the best decisions for your business’s future.