Many small business owners are entrepreneurs who decided to go into business seeking freedom, a better lifestyle, more money or simply because they wanted to run their own show. Some people find it difficult to get a handle on the financial aspects of running their own business. Some of the more common financial mistakes a small business owner makes, and how to avoid them, are discussed in this article.
1. Running Your Business Using Old Accounting Software
This could quite possibly be the most important mistake of all to avoid. In this era of Cloud accounting solutions, accurate management information integrated with daily bank feeds is readily available. Not taking advantage of such information is literally running your business by the seat of your pants. Many small businesses persist in keeping records on outdated software or spreadsheets.
Read more about our tailored Cloud packages here.
2. Failure to Plan
The saying “failure to plan, planning to fail” rings true for many small business owners. Very few have a working budget and cash flow forecast, that is rolled over on, at least, a quarterly basis. As a result, decisions are made based on guesswork and they have no idea whether the actual performance of their business is better or worse than they expected. A solid budget requires the following information, ideally seasonalised and presented on a month by month basis:
This needs to be more than a lump sum figure. Sales should be broken down by product or service line and calculated as the number of sales multiplied by the average sale value.
- Variable Costs
These are costs that vary with sales and, as such, should be driven by your sales forecast.
- Fixed Costs
These are costs that that do not change regularly. Unless there are any significant changes, these figures can be taken from your most recent financial statements and adjusted for any known or expected increases.
Once you have developed a budgeted profit and loss account, you should then create a cash flow forecast. This differs from the profit and loss budget because it is looking at the cash inflows and outflows. As such, it needs to take into account how long your customers take to pay you, how quickly you turn over your inventory, how quickly you pay your suppliers, any loan repayments due and any forecasted capital expenditure that will not appear in the budget profit and loss account.
3. Financing Capital Expenditure from the Cash Flow
As a general rule, and to the extent that it is possible, it is good practice to cash flow the lifetime of a purchase. What this means is that if you are buying stock to sell in the short term, then finance the stock out of your day to day working capital. However, if you are buying a large piece of machinery with a ten year life, then you should look to finance it over ten years.
Similarly, don’t fall into the trap that many small business owners do by going out and purchasing that new car out of your cash flow, simply because you have had a good quarter. Unless you are confident that the strong sales will continue (have evidence to back it up), you could find yourself in a cash flow bind if you empty the bank accounts to buy new assets each time you find you have a bit of surplus cash.
Develop a strong relationship with a bank manager and keep them informed of your plans. Often, the banks will be happy to lend when times are good for your business. You should take advantage of this to properly finance any capital expenditure required to expand your business.
Likewise, the best time to secure an overdraft is when you don’t need it. The banks will be more willing and able to help you out and then, if you hit a rough patch, you have a safety net in place.
4. Cutting Costs Rather Than Driving Revenue
When it comes to considering how to improve profitability, many business owners resort to hacking their costs. That’s all very well, but there is a finite limit to which expenses can be cut and that is zero. At that point, you will have no business. On the other hand, the opportunities to grow revenue, based on the assumption that you manage your growth within the constraints of your cash flow, are limitless. It comes down to understanding the drivers of revenue, which in most businesses are:
- number of customers
- number of times those customers buy from you
- the average sale you make each time a customer buys
Once you understand the drivers, you can implement strategies to increase each of these critical measures. Another thing to be aware of when reviewing costs is knowing where to cut costs. Too often businesses cut back on marketing, which should be the last place where cuts are made.
Similarly, a knee jerk reaction to cutting back on business travel expenses could have an adverse effect of your business.
We are here to help you navigate your way when it comes to running your own small business. If you would like some more information on setting up, and monitoring, your cash flow or understanding what drives your revenue, then please contact us.