Running out of money is one of the biggest killers of new businesses. To keep your startup alive and growing, avoid these five common financial mistakes.
1. Having insufficient capital reserves.
Everyone knows that it takes money to get a business up and running. But sometimes entrepreneurs focus so hard on raising the initial capital that they forget that it takes additional cash to keep the business running until it starts generating a profit. Or, they make over-optimistic projections about expected cash flow and underestimate operating expenses.
When starting a new business, things rarely go exactly as planned. That’s why experts recommend having at least a year’s worth of working capital to see your business through the startup process. To be safe, come up with your best estimate of first-year cash flow needs – and then double it.
2. Mixing personal and business finances.
This can be a difficult trap to avoid, especially when starting out with limited working capital. To prevent this mistake, develop the discipline to keep two separate sets of books – one for your business and one for personal finances. It may take longer to reconcile the books, but it keeps the accounting accurate and makes it easier to determine actual profits or losses.
In particular, beware of using personal credit cards for making business purchases or paying operating expenses. Credit cards often carry high interest rates and annual fees, and can make it easy to overlook business expenditures when closing the books.
3. Lack of forecasting and budgeting.
It’s amazing how quickly startup businesses can burn through their cash. Without a formal budgeting and forecasting process to use as a guidepost, you may suddenly find yourself out of cash and wondering how you got there. Start by developing a basic sales forecast and accounting budget – both annual and month-to-month – to benchmark performance. These should detail how much capital you have on hand, how and when you plan to spend it, and how much revenue you expect to come in each month.
It also helps to have an organized accounts payable and receivable system. If you lack accounting experience, a good software program like Quickbooks can help. Or, you can outsource the accounting function to a third party if your budget permits.
4. Over-extending your financial commitments.
Starting a business is exciting. However, if not kept in check, this excitement can lead to financial decisions that come back to bite you down the road. As you look ahead to where you want the business to be, the temptation to make long-term financial commitments can be hard to resist. Hiring employees before you need them. Renting a larger office than your budget allows. Leasing top-of-the-line equipment instead of something more affordable. These kinds of decisions can lead to financial trouble if you don’t have the cash flow to support them.
Before making any long-term financial commitment, ask, “Do we really need this now? Can we sustain this financial commitment if revenues fail to meet projections?”
5. Not protecting personal assets.
If your business fails, it shouldn’t cost your home and other personal assets as well. However, without the proper legal protections in place, creditors can (and will) come after your personal assets. Protecting yourself starts with setting up your business in a way that identifies it as a separate entity from you – either as a corporation or a limited liability company (LLC). That way, if your business goes under, you can’t be held personally liable for its debts.
After properly structuring your business, keep all business and personal accounts separate. Otherwise, you risk losing the personal protections that a corporation affords. It also helps to purchase liability insurance in case someone sues your business.
Finally, don’t forget to properly pay yourself. It may seem prudent to funnel all profits back into your fledgling business, but paying yourself as an employee offers tax advantages and will keep your personal finances in good standing as your business grows.