Consult any experienced entrepreneur, and they'll likely talk your ear off with stories of mistakes, failures, and lessons they were forced to learn the hard way in early business ventures. The pain that results from financial mistakes is not something that any entrepreneur easily forgets.
Unfortunately, when you're running your own business, there's a certain amount of learning that only truly sinks in after a few hard knocks. But if you do your research, you may be able to learn from mentors who have gone before you and avoid some of the most common financial challenges faced by young business owners.
Here are some best practices that helped me (and hopefully will help you) avoid mistakes most commonly made by young companies and the entrepreneurs who start them:
1. Separate Business and Personal Finances.
Many entrepreneurs start their business using a personal credit card. However, as you well know, business expenses are often much higher than personal ones, so if you are unable to pay off your balance, it will start hurting your personal credit score. When your credit score drops, it's going to affect all your financial transactions, both business and personal.
On the other hand, as a young small business owner investing everything you have into your company, you may not take a salary. But even the thriftiest of entrepreneurs have to buy some Ramen noodles eventually, and so you pay for basic personal expenses on your business credit card. Next thing you know, your business and personal finances are knotted up in such a web that you have no idea where one ends and the other begins.
There are several problems with intermingling your business and personal finances. First, if you're not keeping your finances separate, it likely means you're not keeping detailed business finance records, which will cause problems as your business grows (see point #2). You're also at risk of devaluing your business by increasing your perceived expenses and thereby reducing your profit margin. And ultimately, improper personal use of business finances can potentially get you into hot water with the IRS--and that's something no business owner wants.
Do yourself a favor by separating church and state from the beginning when it comes to your business and personal finances. If that means you need to pay yourself a modest salary in order to stay afloat, so be it. At least this way there is a specific and understood expense going out for personal use, as opposed to a mountain of expenses that leave you questioning where exactly your business profits went.
2. Keep Detailed Records and Receipts.
Failing to keep detailed accounting documents is another avoidable mistake made by startups. This can be an especially common mistake for solopreneurs with home-based businesses. If you're not one to keep a detailed budget in your home life, you may be tempted to behave much the same way with your business. But if you don't know where every dollar of income is coming from, and how every dollar is being spent--you can't know for sure whether you're making a profit, and therefore whether your business is even worth it. And when it comes time to grow your business through financial support from an investor or creditor, you'll need detailed records to prove the value of your business.
3. Expand Your Focus Beyond Sales Figures.
True or False: If you have a growing number of customers or clients from month to month, that automatically means you have a successful, growing business.
Actually, that's false. While sales are a great metric of your growing business, they don't necessarily guarantee an overall profitable business forecast. It's only by balancing sales figures with factors like your expenses, profit margin, and average revenue per customer that you can know for sure whether and to what degree your business is succeeding. That's why you need detailed records for all areas of your business finances.
4. Hope for the Best, But Plan for the Worst.
Entrepreneurs are naturally optimistic. You have to be to meet the challenges involved with starting a business. And optimism is good--it's what gives you the fight to believe in your business dreams and make them happen. But while you're hoping for the best, be sure that your business plans are forecasting the certainty of an eventual rainy day.
Even if your business succeeds overall, you're still likely to experience financial hiccups along the way. A shipment will cost more than expected. Cost of inventory or office space will suddenly rise, or an expensive mistake will be made. For companies that haven't prepared for such eventualities, a small hiccup can spell disaster. But, by planning ahead and padding your budget with a contingency or emergency fund, you can weather the storms of small business ownership with far less panic.
A good rule of thumb is to pad your budget with a 10 percent contingency fund. So whatever you estimate your annual budget to be, go ahead and add 10 percent from the start. Better to have it and not need it than the other way around.
5. Don't Skip Liability Insurance.
If you're operating out of your house, your standard homeowner's insurance policy likely won't cover your business needs, especially if your business owns expensive equipment, such as elaborate computers or other electronic gear. In addition to your homeowner's policy, a general liability insurance policy is a worthwhile business investment. And at as little as $500 for a basic policy, it's money well spent to insure the investment you've made in your business.
6. Check the Books. Check the Books. Check the Books.
Your responsibility for the financial details of your company starts day one and continues for as long as you own the business. As your business grows, you may begin to delegate day to day financial dealings to an employee or outsource bookkeeping to an independent contractor. That's fine and expected as you focus your energies on growing your business. But, even if you have someone you trust handling your books, you still need to have regular oversight of your company's finances.
The unfortunate truth is that without accountability, theft in business is common--even among family members and close friends. Whether it's shaving a few dollars here and there out of payroll or the office supply budget, or more intricate and dramatic theft--if the opportunity arises and there's no one paying attention, some folks just can't resist the temptation. That's why you need to maintain some personal control of your company's finances and know where your money is going.
Even if you're not naturally a financially savvy person, it's your responsibility as a small business owner to be able to read a balance sheet and follow basic financial statements. If you don't, your ignorance will be obvious, and it's only a matter of time before you'll be taken advantage of. So pay attention to the details and don't be afraid to ask as many questions as it takes until you understand your company's finances inside and out.
Have you made any of these mistakes as an owner of a young business? Or are there other financial choices you wish you would have made differently?