5 Most Common Financial Mistakes Small Businesses Make (and How to Avoid Them)

| March 21, 2014 | Business Planning

42-16809689-300x174Running a small business comes with its own challenges. Luckily for new business owners, there are plenty of other small businesses that have already hit these roadblocks and worked their way through them. New businesses can learn from their peers on how to best avoid the common mistakes.

By knowing in advance what the challenges are, you can reduce the learning curve and protect your financial resources, saving yourself a lot of unnecessary grief.

1. Undercapitalization
Having enough money to run your company is a huge challenge for any business. Often, just raising the initial capital, and enough of it, is a full time job. Entrepreneurs tend to be overly optimistic about their businesses. They believe it’ll be self sufficient (cash flow positive) within a year, that they can market for free online, that product development will go flawlessly, and so on. Seldom do things go according to plan. Many business owners discover that it takes at least an additional year to grow their company than they originally thought. Meanwhile, they are using up their initial investment, and quickly running out of funds.

To avoid this, be conservative when projecting forward, and then be even more conservative. Have others look at your plan and ask for honest advice. Look to mentors to give you feedback on your plan and bring up thoughts on hurdles you may face that you may not have thought of. At a minimum, whatever you believe your capital needs will be, most likely you’ll need double that amount.

2. Poor accounting practices
It can be easy to lose track of where things stand financially. Simply monitoring your cash in the bank is not enough. The lack of any financial reporting means that you have no insight into any financial trends, which minimizes your ability to be proactive and make prudent financial decisions. It’s easy to not worry about your finances when you have money in the bank and see no end in sight,. But, when the cash flow dwindles over time suddenly it becomes panic-time.

Accounting isn’t as scary as it seems. Hiring a part time bookkeeper who can run basic financial reports for you will go a long way. These reports allow you to track performance, see where your cash is being spent, and help you project forward where your business is headed.

3. Entering long-term financial commitments too early
Many new business owners want to charge ahead once your company’s funding is in place. A lump sum of money can give a false sense of security and make one feel like there’s no end to the cash. Hiring several employees, renting bigger office space, signing up for insurance policies, and leasing equipment are often the first places money is spent.

Without knowing how fast, or slowly, your business will grow, this creates a real problem. Now you have several commitments that are difficult to get out of. Instead of being aggressive with spending, be as conservative as possible. When your company begins to experience growing pains (under staffed, cramped quarters, can’t fill orders fast enough, etc.), that’s when you should consider spending money on more space and additional employees, not beforehand.

4. Allocation of resources
When evaluating all options for spending capital, weigh the cost-benefit of each option. Ask yourself questions such as “Which is the better investment: hiring an additional employee or moving into a larger space?”

By prudently allocating the resources you have, you will prevent over spending, and force yourself to truly consider why you are spending on a specific resource. Weighing the pros and cons of a specific expenditure will help determine what you can live without, or will aid you in brainstorming more cost effective alternatives.

5. Lack of forecasting and budgeting
Having a plan of action is essential for your business. A sales forecast and expense budget is the road map you need in order to guide your business. Quite often, small business owners have a limited amount of time, and creating a budget isn’t at the top of the list. The problem is without a road map, you’ll never know if you are on track.

Develop even a simple forecast and budget so you can benchmark your performance. By having a month-by-month guide that maps out where you plan to spend your capital, you’ll know if it will last as long as you expected.

By implementing practices to avoid these 5 common mistakes, you’ll save yourself a lot of time and resources, and be able to focus your efforts on growing your business instead. Your time as a small business owner is best spent being proactive, not reactive.