Many small businesses owners typically got into business seekingfreedom, a better lifestyle, more money, or simply because they wantedto run their own show.
Although they possess business skills, financial acumen is rarelychief amongst them. In this article, I list the 5 most common financialmistakes.
1. Fail to plan, plan to fail
Few small businesses have a working budget and cash flow forecastthat is rolled over on (at least) a quarterly basis. As a result, theymake decisions based on guesswork. A solid budget requires the following information, ideally seasonalised and presented on a month by monthbasis:
• 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 betaken from your most recent financial statements and adjusted for anyknown or expected increases.
Once you have a budgeted profit and loss account, you should thencreate a cash flow forecast. This differs from the profit and lossbudget because it is looking at the cash inflows and outflows. As such,it needs to take account of 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 profit and loss account.
For a thorough budget that could be presented to a bank to get financing, you should also complete a budgeted balance sheet.
2. Financing capital expenditure out of cash flow
As a general rule (if possible), it is good practice to cash flow the lifetime of a purchase. By that I mean: if you are buying stock to sell in the short term, then finance it out of your day-to-day workingcapital. But if you are buying a large piece of machinery with aten-year life, then you should look to finance it over ten years.
Similarly, don’t fall into the trap of spending your money on flashyassets out of your cash flow after just one good quarter. Unless you are confident that strong sales will continue, you will be strapped forcash sooner or later.
Form a strong relationship with a bank manager and keep them up todate with your plans. Often, the banks will be happy to lend when timesare good. Take advantage of this to properly finance any capitalexpenditure required to expand your business. Similarly, the best timeto secure an overdraft is when you don’t need it. If you hit a roughpatch, at least you have a safety net.
3. Failing to understand the difference between profit and cash flow
In my work with accounting firms, I admonish accountants to presentfinancial information to their clients in layman’s terms. I recommendcreating a chart to explain the difference between profit and cash flow.
I have lost count of the number of times accountants have told methat their clients love this chart.
It is a simple concept, and looks something like this:
The chart depicts the open cash position of the business on the lefthand side; it then adds the profit for the year. Most small businessowners see that they have made a profit on paper (in this case,somewhere in the order of $45,000) and wonder why they have zero (or asin this case, negative) cash in the bank by the end of it.
This chart demonstrates why that has happened. It accounts fornon-cash items such as depreciation. It then looks at ‘below the line’items such as dividends or owners’ drawings. Importantly, it then takesaccount of moves in inventory, accounts receivable and accounts payable.
For example, if your customers on average are paying you 14 daysslower than they were last year, your cash flow will suffer. Other items such as the capital element of loan repayments (not shown on the profit and loss account) are displayed, leading the reader down to the closing cash position. Armed with this information, you can implementstrategies to improve your cash position in each area.
4. Cutting costs rather than driving revenue
When considering how to improve profitability, many business ownersresort to tackling costs. That’s all good, but there is a finite limitto which expenses can be cut – zero.
On the other hand, the opportunities to grow revenue, assuming youmanage your growth within the constraints of your cash flow, arelimitless. It comes down to understanding the drivers of revenue, whichin most businesses are:
• 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 put in place strategies to increase each of those critical measures.
5. Running your business from a spreadsheet
Of all of the mistakes listed, this is quite possibly the most important to avoid. In this era of cloud accounting solutions it’s so easy to get accurate financial information especially withintegrated bank feeds connecting your accounting software with yourbanks.
Failing to take advantage of such information is like running thebusiness by the seat of your pants. Yet many small businesses persist in keeping their records in a spreadsheet or worse, in a shoebox!
Talk with your accountant today if you feel that your accountingrecords are inaccurate, unhelpful or obsolete. In fact, a proactiveaccountant can help you avoid all five of the key financial mistakes Ihave outlined in this article, helping to set you up for more profitable days ahead.