Many factors go into making a small business a success. Some factors, however, can be more challenging than others, especially when it involves financial management. Whether it's securing equity capital, borrowing money, separating personal finances from business finances, or managing cash flow, there are a number of "potential landmines" that many small business owners are not adequately prepared to handle. Following are six financial pitfalls for small businesses to avoid and important tips to consider when dealing with business finances:
1. No cash reserves. The lack of cash reserves is a huge burden and one of the biggest mistakes many small businesses make. The cost of starting a business may be small depending on the business, but it is also common for startup businesses to have negative cash flow during the initial stages of the business. Sufficient cash reserves must be estimated and available until the business creates a positive cash flow.
2. No cash flow forecast. Predicting future cash flow needs after startup is vitally important for a small business and correlates with building sufficient cash reserves. Without knowing future cash flow needs, a small business does not know how much cash will be needed to operate, service debt, etc., or what should be held in reserves. Cash flow budgets are useful and necessary tools of cash flow management.
3. Borrowing. Small businesses must be disciplined when borrowing money and creating other forms of debt such as purchasing on credit cards or leasing equipment. There must be a margin of safety between borrowing and debt servicing. Many times, it is easier to borrow than to repay. When a small business becomes overextended regarding debt, catching up can be difficult and, at times, impossible.
4. Control spending. It is imperative for small businesses to determine which purchases are absolutely necessary and which ones are not. Luxury purchasing for a small business can be costly in terms of negative cash flow and debt.
5. Commingling business and personal finances. Commingling personal and business finances is a recipe for disaster in a small business. Although a sole proprietorship may be taxed along with the owner’s other forms of income, a small business should still be treated as a distinct entity keeping business and personal finances completely separate -- separate checking accounts, separate billing for expenses, separate everything. When business expenses are paid personally, then an expense reimbursement should be submitted to the business. Likewise, business income should not be deposited into a personal bank account. Writing checks back and forth between business and personal accounts may seem like a waste of time; however, separation of these accounts is essential.
6. No professional assistance. Professional advice, whether in the form of small business consulting, financial, or tax advice, can help a small business avoid financial issues. Small businesses should concentrate on what they know how to do best and leave the rest to knowledgeable pros.
