It is shown in Research that in their first year, 20% of small businesses fail. In their second year, 30% of small businesses also fail, and after five years in business, 50% of small businesses fail. Also, in the tenth year in business, an astounding 70% of small business owners fail. Why? What can we learn from these colossal failures?
Maybe they are out of cash, maybe they cannot handle their finances, maybe they are bleeding capital. Whatever the reasons are for their finance mistakes, a collapse just doesn’t happen suddenly. The cracks in the foundation start way before the actual disaster. In today’s article, we will be looking at the 7 mistakes businesses make in their finances that result in the failure of a business and how you can avoid these failures.
Mistakes Businesses Make In Their Finances
1. Poor Cash Management
One of the leading causes of business failure is not enough cash. Small businesses do not estimate their cash inflows and outflows. Startups are not the only businesses to face failure due to a lack of cash. Even established businesses can face problems due to a shortage of cash.
There is a stark difference between cash flow and sales. There can be plenty of sales on your register, but unless you are paid in advance, certain expenses will be due before you collect anything from your customers. If you fail to collect your payments, you will not be able to pay your bills on time.
Similarly, growing businesses can face a similar problem. You need cash to be able to work in a wider area; which means you will need cash to pay your staff, your taxes, and overhead expenses.
Another problem for businesses can come due to a cash flow problem. You might not be able to calculate the growing debts or falling profits. To avoid this, take out the time to estimate your costs and buy enough time for yourself to get paid. Have a schedule for invoices, be aware of collectibles and assess your cash position weekly, or monthly at an absolute minimum.
2. Failure to Create a Budget
A budget is something that allows you to manage your expenses for a set period of time. Your finances are unmanageable if you do not have a budget set out for the month, quarter, or year. If you are not vigilant about your budget or fail to follow the one that you created, then it will harm your expenses, tax obligations, and insurance payment.
You will not have enough in the bank for important purchases, which in turn will hinder the growth of your business. If you end up needing a loan or get indebted to your bank it will incur an extra interest expense on your business, which you may want to avoid.
3. Not Opening a Credit Line
The worst time to open a line of credit for your business is when you need it the most. When your business is on the brink of failing, you will not find any funding to rescue you. Seek a solid credit line when your business is flourishing. Your type of credit will depend on the type of your business.
Additionally, the purpose of the credit and its size will also matter. Your funding will depend upon your needs that include — traditional banks, online lenders, credit card purchases, and specialty lenders. Interest rates will vary from source to source. Explore your options and select what suits you the most. Compare the interest rates of different banks, local lenders, and online lenders. Diversify your options and select the best one.
4. Initial Overspending
Your optimism during growth may lead you to overspend and invest too much. Until you have researched your needs and created a rational budget, do not spend a dime. Divide and plan your budget for hiring staff, ordering inventory, and the capital that you will spend on marketing. Be realistic with your budget.
Compare the statistics with other businesses and keep a few questions in mind. How did others handle this phase in their business? What was their budget? How long did it take them to see ROI? What was the scale of their investments? How many employees did they have? Did they have an IT department? How was their marketing campaign?
All the aforementioned questions will help you devise a solid plan to avoid a major disaster. This is one of the most common financial mistakes business owners make — if startups get trigger-happy on spending too much in the beginning then they will not last very long.
5. Mixing Business and Personal Accounts
Surprisingly, many business owners don’t believe in having a separate business account for their business. This is where the problem with financial management starts. Not having a separate business account will result in issues of mixing revenues, profits, and expenses from personal and business use. And eventually, you will not be able to track your finances properly.
The real problems occur when you are doing your taxes. If you are unable to differentiate a business from a personal purchase — or fail to calculate your business tax, profits and losses for the year, it will get a lot worse when the CRA does an audit. If they believe you have used the money for personal uses under the label of a business expense, then that will add to the list of problems you have.
To avoid this jam, it is highly recommended to separate your business and personal bank accounts. This will help you keep track of your taxes, revenues, and loan payments if any. No matter what you do, you have to remain within the defined financial budget for the business.
6. Neglecting Business Insurance
In small businesses, your emergency funds will protect you from unforeseen accidents. But, they might not be enough to save you from a total disaster. In comes your insurance plan, which minimizes the risk of a total collapse. Not all plans are going to be the same, but there are three types of plans that you should look for to safeguard your business.
- Workers’ Compensation Insurance
Ensure the payments of your workers via this policy. It covers their medical, work-related injuries and provides benefits for them. For example, if a worker gets into an accident and needs major surgery. This plan will help in providing medical care, lost wages, and disability benefits.
- Commercial Property Coverage
New owners should consider this policy to safeguard their physical location and other assets. This will cover your inventory, tools for production, equipment, and even the furniture in your office. This will protect from natural calamities, such as fires, earthquakes, or accidents.
- General Liability Coverage
This is a holistic policy that will cover both medical injuries, property damage, and asset protection. In a case of an injury or a fire accident, you would not have to bear the expenses out of your pocket. Sit with the ease of mind that your business, your employees, and your assets will be looked after.
7. Under Pricing
Charge too much and you lose sales to a competitor. Charge too little and you do not make any profits. Finding the right balance is hard. Small businesses, or those that are just starting out, often try to cut their competition by charging too little. Sometimes, owners do this because they have not calculated the cost of their labor, their expenses, and profit margins.
Make sure you do not go into loss just to get your foot in the door. We understand that competition is fierce, but in order to survive, one has to accurately determine their expenses, keep the profit margin enough so that your business stays afloat, and price your customers smartly.
Not Using Financial Tools
Financial tools are essential for small businesses. Keep track of your books via accounting software. Manual methods are outdated, slow, and inconvenient. To achieve accuracy and avoid any form of corruption, get accounting software that is suited to your needs. Find a cost-effective software solution that allows you to scale over time. Such software will not only help you declutter all the mess in your business, but it will provide you with the necessary data to make informed financial decisions.
This article is written with only one perspective in mind and that is to make you understand the mistakes businesses make in their finances which often lead to financial disasters, ultimately resulting in insolvency. You need to be aware of the mistakes in finance people make and avoid them to have a viable business. The good news is that there are services available for startups and other new businesses to help with all these corporate challenges, including accounting, taxes, HR, benefits, and more.
If you want to learn more about them, check out our website for more informational articles. Are you holding back any questions which might help you better understand what your business needs to look out for? Let us know in the comment section. Or email us at email@example.com