Small business owners are often experts in their niche and the products or services they provide—but, in many cases, they don’t have the same level of expertise in running a business. Managing finances is one area where small business owners often make mistakes. These mistakes can be very costly, too. Not only will it likely mean you’re spending more than you need to, but they can also stymie business growth and prevent you from reaching your full potential. Here are five of the most common financial mistakes and what you can do instead to keep your small business in optimal financial health.
Mistake 1: Not separating personal and business finances.
It may seem easier on the surface to have your personal and business funds in the same account, especially if you’re a solo owner-operator or sole proprietor. In reality, though, separating business finances from those of the owner is more efficient in the long run, and becomes increasingly so as the business grows.
Having separate, dedicated accounts for a small business has a number of benefits, including:
- It’s easier to track and rectify your expenses, revenue, and cash flow. When your business and personal finances are tangled together, you have to rely on the accuracy of your balance sheet and expense tracking to monitor your business’ financial health. Separate accounts give you a quick way to verify that your balance on paper matches what you have in the bank, allowing you to maintain a more accurate picture of your financial health.
- It’s easier to get funding. Most lenders will want to see proof of your current financial status before they’ll give you a business loan, and the same is true of investors. This is much easier to provide when you have an account that is only used for business finances.
- You’ll be more prepared for tax season. Having all of your financial information in one place is just as beneficial when you’re filing taxes as it is for showing potential lenders and investors. Separating your finances also allows you to take full advantage of any deductions, tax credits, or other benefits you may be eligible for.
- Your personal assets are better protected from liability. If you operate as an LLC or corporation, your personal assets are safe if you face any legal actions. That may not be the case if your business finances are tangled with your personal funds, though.
The solution: Establish a separate business bank account and financial tracking system from the start.
Setting up a business bank account is easy. As long as you have a FEIN and your business is registered with your state, you can obtain a bank account for your business. Doing this can have other benefits, as well, since business bank accounts often come with features that personal accounts don’t. It also enables you to do things like get checks under your business name, and can make you eligible for a wider variety of loans from the institution where you do your banking.
A dedicated bank account is the minimum you should have for your business. You can expand your financial footprint by adding a business credit card, or getting store cards in your business’ name at the places you frequently shop for supplies and materials.
Mistake 2: Poor cash flow management.
A business can be profitable on paper but still find itself in a tight financial spot if all of that money is tied up in inventory, assets, or investments. This could lead to situations where you’re anxiously waiting for a payment to hit your account so you can pay your bills on time—not the ideal place to be for any business.
Effective cash flow management means you know exactly how much you have available at any given moment, as well as how much of that is earmarked for upcoming expenses and what you anticipate coming in from recent sales. Keeping track of this information over time allows you to identify trends and predict things like:
- What products or services sell well, and which ones don’t
- When you typically have financial shortages or a cash surplus
- What times of year are consistently the busy or slow periods
All of this enables you to make more informed financial decisions, so you know exactly when it’s smart to invest your profits (and where to do so) and when it’s better to keep that cash in your account.
The solution: Establish good cash flow management habits.
Accurately tracking your revenue and expenses is the first step to effectively managing your cash flow. Along with that, here are some other tips to improve your cash flow management:
- Secure lines of credit before you need them so you’re not scrambling if you end up short. Often, you can discuss potential lines of credit with your business bank and not have any additional expenses associated with them unless you use them. Opening business credit cards can serve this function, as well, giving you another way to handle expenses when you’re short on cash.
- Schedule your payments in advance so that you can see what expenses you have coming up and plan accordingly. This is particularly important for infrequent, large expenses, such as quarterly tax payments.
- Incentivize on-time and early payments from customers, such as an early payment discount or increasing penalties on late payments. This can help you more accurately predict when you’ll be getting revenue based on your operations and sales.
- Take the longest amortization period possible on loans. This reduces your payment burden and allows you more financial flexibility. You can always pay more than your minimum when you have more cash to go around to limit the additional interest you’ll end up paying with a longer repayment period.
Mistake 3: Avoiding debt.
Everyone agrees that having too much debt is a bad thing, whether you’re an individual or a business owner. When your debts outpace your income, you can find yourself perpetually underwater and sinking further with each passing month, especially once you find yourself missing payments.
That doesn’t mean that all debt is bad, though. Taking out a loan or line of credit can be a smart way to encourage business growth and can make you more profitable in the long-term. For example, you might take out a loan to buy or upgrade equipment that lets you do more work faster, increasing your profitability, or could use a loan to open a second location and potentially double your revenue.
Especially in the early stages of a business, it can take a long time to earn the revenue you need for these kinds of large expenses. Waiting to do so until you can pay out of pocket can prevent you from growing and lead to stagnation. Taking out a loan also helps to build your business credit, which can open up more opportunities for financing and growth down the line.
The solution: Approach debt strategically.
The best type of debt that a business can have is one that aligns with your business goals and actively leads to growth. If you’re considering an expansion like a new location or product line, or find an opportunity like steeply discounted inventory or a great deal on new equipment, a loan can be the best way to go about it. This may even be true when you are capable of paying for it out of pocket but doing so would disrupt your cash flow and emergency preparedness.
Of course, you also want to do your research before you take on any new debt. Take the time to compare rates and terms from multiple lenders to find the best option. Also make sure you have a plan for how to repay the loan, and that adding a loan payment won’t prevent you from paying your other expenses.
Mistake 4: Failing to plan for unexpected expenses.
No matter how carefully you plan, you can never predict everything that happens. There will always be unexpected expenses in a business, from sudden equipment failures to natural disasters, economic disruptions, or abrupt shifts in customer habits or needs.
If you operate with a very tight financial margin (or no room for error) in your income and expenses, you could be in trouble if an unexpected expense hits your account. Leaving yourself a buffer can prevent this kind of disruption from becoming an emergency that torpedoes your business.
The solution: Establish an emergency fund and build contingencies into your financial planning.
When creating financial projections for your business, make sure to include a line item for the unexpected. A business saving account can be a great place to keep an emergency cash supply, and you’ll usually get a slightly higher interest rate on this money, as well, compared to keeping it in your checking account.
Taking the advice above about setting up lines of credit before you need them can help here, too. This way, you’ll have another avenue to fall back on should you run into financial hardship. While it’s not ideal to pay for recurring expenses on credit, it can be a solution in a pinch.
Mistake 5: Getting the wrong insurance.
Insurance can feel like an unnecessary expense when things are going according to plan. This can lead some business owners to purchasing the bare minimum policy they are required to have by law, or skipping on some types of insurance entirely. You can possibly even get away with this for years without a problem—but the second you do need to make a claim, that cheap insurance can quickly turn from a money-saver into a liability.
In some cases, a business will need to have an insurance policy of a certain amount in order to secure clients and contracts. This tends to be especially true for B2B businesses that work with government agencies or large corporations. Lenders may also require a business to have coverage before they’ll extend a line of credit. In these cases, not having the right insurance can actively impede your business growth.
On the other side of things, this doesn’t mean that every business needs a top-of-the-line, huge insurance policy. Coverage that you don’t need or won’t use is a waste of money, and one that can add up over the life of a policy.
The solution: Find your coverage Goldilocks Zone.
The language used in insurance documents can make them intimidating for many people, especially those who aren’t well-versed in the financial side of business ownership. Meeting with an insurance agent can help you make sense of the language in these policy documents. A professional can also help you identify what type of insurance you need based on your industry, business size, and future growth plans.
It’s worth the time and effort to fully understand whatever coverage you’re considering. This will give you the peace of mind to know what you’re covered for should something go wrong, and will help you make sure you’re not paying for coverage beyond your needs. In other words, you can find the coverage that’s not too much, and not too little–but is just right.
