Launching a business can be a challenging ordeal for new entrepreneurs. From filing the necessary paperwork to rounding up a competent team, business owners have a lot on their plate throughout the journey.
With all these variables, it’s very likely for business owners to make some wrong calls when setting up and running their business.
In fact, most businesses tend to accumulate more losses than profits in the first five years of their lifespan. These financial losses may cause these businesses to shut down for good.
If you want to minimise these losses, then you should aim to gain some awareness of a few common financial mistakes that business owners are prone to making. This can help you avoid going down that route and instead lead you down a path where you can maximise your profits.
Without further ado, here are eight common financial mistakes that entrepreneurs tend to make that you can avoid.
1. Not Paying Loans on Time
One of the worst things business owners can do is leave their debts unpaid. Unpaid debts can incur late penalty fees, which can increase the final loan amount at the end of the term.
Furthermore, this can also increase your interest rates and damage your credit score, making it harder to access loans from financial institutions in the future.
To prevent this from happening, be sure to have a solid debt repayment scheme to ensure that you’ll never miss a due date. You can set up an automatic transfer system to stay on top of your debt obligations, for instance.
The order of priority when clearing expenses is your debt first, then bills, then everything else. Be sure to have enough capital at the end of the month to clear your debt.
By doing so, you can maintain a good credit score (which can help you get better loan deals) and continue running your business in a financially sound manner.
If you need more tips on how to finance your company, this article can give you some additional loan and financing tips for growing businesses.
2. Not Making Financial Goals and Projections
If a business owner fails to make goals and targets for their business to reach, it’s equivalent to essentially shooting at the moon with a slingshot.
To be a successful business founder, you need to be able to define success and meet micro goals that can position you for success.
The most effective goals are SMART goals. These types of goals provide a structured and time-sensitive outline that businesses can use as guiding targets for their long-term success.
Besides goals, making financial projections is also essential. These projections essentially forecast a range of revenue and expenses based on predicted market factors.
Making one before you start conducting business is crucial since it helps quantify the feasibility and profitability of a project.
By setting effective goals, business owners can steer their business in a more precise direction. This, in turn, can make long-term business objectives more achievable.
3. Mixing Personal and Business Finances
A common mistake entrepreneurs make is putting personal and business finances in one bank account. While this may seem like a convenient money storage solution, this will inevitably lead to confusion come bookkeeping and taxing season.
This is especially true if you’re letting a financial team do your accounting work for you—as they may be unable to understand the context of the transactions and cause a lot of errors.
As such, be sure to distinguish personal and business accounts by making a separate bank account for your business as soon as you can. Refrain from mixing personal and business bank transactions. This can help keep your business operation running smoothly, professionally, and legally.
4. Getting More Debt Than The Business Can Handle
Over-leveraging may seem like a good way to build your business fast, but if done wrong, this can be the cause of major financial distress.
It’s critical for you to be strategic in how you leverage debt. Doing it correctly can potentially earn you higher returns, so don’t cross it off completely. Just be strategic in your approach.
One way to do it is by ensuring that your coverage ratio is high. A coverage ratio is calculated by dividing a company’s earnings before interest, taxes, depreciation, and amortisation by its total debt payments.
When the coverage ratio is higher than the debt threshold, this can indicate a lower likelihood of defaulting.
Another critical factor to consider is cash flow. If your cash flow is low or steadily declining, you need to pivot to a more conservative debt strategy as this can put your business in a precarious situation.
If you need to take on more debt, clear off existing debt as quickly as you can. You can consider consolidating or refinancing as potential ways to reduce your monthly repayments.
5. Poor Pricing Strategy
If your business has good sales volume but is still facing financial hardship, then you may be suffering from a poor pricing strategy. This can cause excessive strain in your ability to expand your company to new heights.
Of course, the basic strategy is to price your product higher than its fixed and overhead cost. But you should also have an ideal profit margin for your product that you can sustain in the long-term without compromising on demand. Add all these together and you can get the price per product.
Finding the balance will require research and balancing. Be sure to conduct your market research to determine the best mark-up percentage for your product or service.
6. Inefficient Inventory Management Systems
Operational efficiency is closely tied to business profitability. If you have poor inventory management systems in place, this can lead to merchandise not being utilised or being under supplied.
It’s essential to invest in a good inventory management system that allows you to accurately forecast demand based on historical and seasonal data.
This can lessen the inefficiencies in the acquisition and supply chain process, which can ensure that your products are fully ordered and available at the right time.
7. Not Getting Business Insurance
A big mistake that new business owners make is failing to insure their business.
While you’re likely to prioritise being conservative with your budget early on, you must allot some funds to get the right insurance. This can help you in case your business enters any lawsuit that may require a significant payout to a third party.
There are multiple types of business insurance that businesses can get. Some are mandatory by law, like workers’ compensation insurance and personal liability insurance.
Others are optional but highly recommended, like personal income, product, accident, and cybercrime insurance.
Depending on your business’s affinity towards risk, it’s important that you get enough insurance coverage to protect your business in case things go awry.
While you can’t feel the effects of making these monthly payments most of the time, when it does need to get claimed, you’ll be happy that you have a payout to help you during these turbulent times.
8. Failing to Apply for A Business Structure
Many new business owners fail to set up a proper business structure. This can backfire. The right business structure helps protect the liability of business owners and protects their personal assets (such as a house or car) in case their business defaults.
One of the most common business structures new entrepreneurs get is the sole proprietorship business model. While this structure grants full control to the owner and is more affordable and easier to set up, it comes with the drawback of putting the owner’s personal assets at risk in case the business defaults.
Other business structures that may be worth exploring to mitigate this personal liability include partnerships, corporations, and limited liability companies (LLCs). LLCs are great in particular since they have the right mix of alternative tax benefits and protection from liabilities.
Furthermore, an appropriate business structure also enables businesses to get funding and partnership opportunities. This is because it stamps a sense of legitimacy to your business, which can signal potential partners to involve themselves with your business.
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