Many small business owners are entrepreneurs who started their business to seek freedom, gain a better lifestyle, earn more money or simply because they wanted to run their own show.
Although ambitious, small business owners sometimes don’t have the knowledge required to make informed decisions about their finances from the start.
Following are four of the most common mistakes small business owners make and how to avoid them.
Failing to plan
Few small businesses have a working budget and cash flow forecast that is rolled over on a quarterly basis (as a minimum). As a result, decisions are made based on guesswork and it’s difficult to tell if the business’s actual performance is better or worse than expected.
A robust budget should have the following information, generated on a month-by-month basis:
- Sales – not just a lump sum figure, but 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 – unless there are any significant changes, these can be taken from your most recent financial statements and adjusted for any known or expected increases.
Once you have developed a budget with profit and loss accounted for, you should create a cash flow forecast.
This is different from a profit and loss budget because it looks at the cash coming in and going out. It needs to take into account how long your customers take to pay you, how quickly you turn over inventory, how quickly you pay your suppliers, any loan repayments due and any forecasted capital expenditure that will not appear in the budget’s profit and loss account.
Ideally the budget created should have enough detail to be adequate to present to a bank for the purpose of raising finance, this should also include a budgeted balance sheet.
Financing capital expenditure out of cash flow
As a rule, it is good practice to cash flow the lifetime of a purchase.
For example, if you are buying stock to sell in the short term, then finance it out of your day-to-day working capital. But if you are buying a large piece of machinery with a ten-year life span, then you should look to finance it over ten years. This will free up your cash flow.
Another way of protecting your cash flow is to be measured with your spending. If you have a good quarter, don’t be tempted to purchase an expensive item (such as a car) with surplus cash, unless you are confident (and have evidence to back it up) that your strong sales will continue.
Another recommendation to safe guard cash flow is to form a strong relationship with your bank manager and keep them up to date with your business plans. Often, banks will lend to you when times are good, so you should take advantage of that to properly finance any capital expenditure required to expand your business. Similarly, the best time to secure an overdraft is when you don’t need it, as opposed to when/if you hit a rough patch.
Cutting costs rather than driving revenue
When considering how to improve profitability, many business owners resort to cutting costs. But generally, there isn’t much to cut before the business as a whole suffers.
On the other hand, the opportunities to grow revenue are limitless, assuming growth is managed within the constraints of the cash flow. 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 these drivers, you can put in place strategies to increase each of those critical measures.
Another thing to be aware of when reviewing costs, is knowing where to cut.
For example, some businesses cut back on marketing which can often be the last place you should be making cuts. Similarly, a knee jerk reaction to cut back on travel expenses could see an adverse reaction (a recent study conducted by Oxford Economics and commissioned by the US Travel Association found that 57% of businesses surveyed felt that cutting their travel costs during the recession in the US hurt their business.)
Running your business from a spreadsheet
This is probably the most important thing to avoid for small businesses. In this era of Cloud-based accounting solutions, accurate management information integrated with daily bank feeds is readily available. Taking advantage of this technology can take the stress and worry out of managing your businesses finances.
Talk with us today if you feel that your accounting records are inaccurate, unhelpful or obsolete. In fact, we can help you avoid all four of the key financial outlined in this article, helping to set you up for more profitable days ahead.