Common Financial Pitfalls & How to Avoid Them

Many of the mistakes that small business owners make are minor and can be easily fixed. However, some major ones, mostly involving money and cash flow, can have devastating effects on their businesses. It's important to familiarize yourself with the common pitfalls that new business owners often fall into so that you can protect your business and avoid making the same mistakes.

1. Not having a cash cushion

Your access to cash has a lot to do with the success of your business. You may have good numbers on paper but without the cash to show for it, your business will be unable to cover expenses, make payroll, and take advantage of business opportunities.

A cash reserve provides a cushion that you can fall back on in case of unforeseen expenses. Whether it's a delay in supply delivery or equipment suddenly needing a repair, having enough cash to meet sudden expenses puts you in a strong position.

Additionally, cash reserves also insulate you from the ups and downs of seasonality and the economy. All industries experience peak seasons and slow sales in any given annual cycle. Without enough cash, the slower months can drag on and your business may end up with negative cash flow. More importantly, adequate cash allows you to fund your growth. Many business opportunities require cash upfront, and while bank financing and loans are indeed available to you, having enough cash gives you the confidence and leverage to actually take on these opportunities for growth.

2. Having both personal and business accounts in one

The convenience of having just one account for personal and business savings, checking, and credit card transactions is tempting, especially for first-time entrepreneurs. Starting a business account is also more difficult since some banks impose strict requirements in opening this type of account. However, not keeping your finances separate can have serious repercussions for both you and your business.

Having just one account for both personal and business transactions won't provide a clear picture of your business’s financial health. You'll have difficulty tracking how much money your business is making or losing in a given month. This makes accounting your business’s financial position inaccurate, affecting your ability to plan ahead and forecast.

As a consequence of having just one banking account, you may experience difficulties when it's time to pay your business taxes. You won't have accurate values for your profit or loss for the year, and you may need the right information to determine your deductibles.

3. Passive collection of receivables

Payment delays and non-payments are some of the biggest challenges that small businesses face. Most small businesses operate on a tight budget and because of this, even a few late payments can put you at risk. Two million British businesses, which is over a quarter of UK SME's currently fall victim to late payments.

Some industries are more prone to late payments than others. For instance, the construction industry has been scourged with late payments to the point that it's often treated as the norm rather than the exception.

For better cash flow management, you need to be active in contacting clients and collecting your receivables. Otherwise, they are more likely to stretch pay periods and delay paying you. And the longer payment is delayed, the harder it will be for you to collect it.

The first step is to check your accounting books and look for client accounts that are due. Give them a call or email and, if possible, drop by their office to talk to them. You can also encourage early payment by imposing additional fees if they pay past the due date. Aside from this, you can specify a billing schedule during your initial talks so that clients know when to expect the invoice to arrive and when they need to pay.

4. Impulse spending and overspending on start-up costs

It's easy to be swept up in the excitement of starting a new business and be optimistic about how your business will actually do. However, that excitement can sometimes lead to overspending. For example, many small business owners fall into the pit of buying more inventory than they need, or buying a brand-new and expensive piece of equipment instead of a reasonably-priced one. Overspending on start-up costs and impulse spending can creep up and, before you know it, you're eating through your bottom line.

The key to avoiding the pitfalls of overspending is to create a realistic budget and stick to it. Your budget should be based on your cash flow and you should make conservative projections and account for unforeseen expenses. More importantly, always update your budget if there are changes in your business performance as well as the introduction of new expenses. It’s hard to stick to it but it’s always worth it.

5. Extending sales on credit without vetting the client

As a new business owner, one of your priorities is to make it easy for customers to purchase your services and products. To facilitate a smoother transaction, you can sell products on credit. However, one of the biggest financial mistakes you can make is granting credit without checking a client’s credit history.

There will always be a chance of non-payment every time you extend credit to customers. However, you can minimize this risk by being selective of your clients and checking their credit history before closing a deal. You'll be saving yourself from future headaches if you turn down a client with a bad credit history. That said, if you really want them as customers, you could ask for a higher deposit and impose stricter credit terms.

About the Author

Chris Woodard is Co-Founder of Handle.com, a software company that helps contractors, subcontractors, and material suppliers with late payments. Handle.com also provides funding for construction businesses in the form of invoice factoring, material supply trade credit, and mechanics lien purchasing.