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How to Avoid the Most Common Financial Pitfalls in Small Business

Business owners have a lot on their plates. From sales, fulfillment, and hiring to HR, payroll, and marketing, there’s a lot to do and a lot that can fall by the wayside.

One of the things that can seem non-urgent—until it turns into a crisis—is financial management. Ironically, the mistakes you make here can be the most costly. These errors can not only suck up your time (that would be better spent somewhere else), but can dry up your business’s cash reserves or social capital with investors. Thankfully, from mixing funds to surprise expenses, most money mistakes can be averted.

Here are seven ways to avoid the most common financial pitfalls for small businesses.

Know your Numbers

Small businesses often know too little about their numbers. When starting out, many companies care only about their profits and neglect financial reports. They don’t even realize that they’re out of cash until it’s too late.

To remedy this, you need to build a budget. You may not know exactly how much to allot to each category, but a rough plan is better than no plan. Be sure to make room for unforeseen expenses, because they will come. Then, revisit your budget frequently. Regularly evaluate cash flow and keep an eye on your profit margins. You need to know exactly what is coming in and what is going out.

Not only does setting a clear budget help increase financial discipline, it helps you to plan for growth. Most accounting products will automatically produce reports for you—so take advantage of them! Run reports monthly (at a minimum) to intelligently analyze expenses and plan for pinch periods.

While you may start out with a good financial cushion, the time may come when you need to seek out funds from a bank, investor or lender such as Business Impact NW. These lenders will be more generous if you can demonstrate a current and detailed knowledge of your financial standing.

Separate personal and business funds

Whether out of convenience or presumed necessity, commingling personal and business funds can be disastrous for small businesses.

Most often, the guilty parties are sole proprietors or independent contractors who don’t see a need to separate. Unlike larger corporations, these small business owners are under no legal obligation to isolate business funds. However, there are still strict tax laws related to personal draws and blended funds will raise red flags for anyone looking through your records—potential partners, purchasers and even the IRS.

Creating a separate account for business transactions will:

  • Simplify bookkeeping and taxes
  • Make monitoring cash flow easier
  • Paint a more accurate picture of your financial health
  • Provide your business with credibility
  • Reduce your personal liability
  • Change your money mindset

Whether you are bringing in $100 a year or $100,000, creating a separate business account will make a big difference for your finances. This doesn’t mean that money is untouchable. In fact, you can (and should) still pay yourself a salary. This just makes business transactions way easier to track and eliminates many financial and liability risks.

Don’t Overspend

You have to spend money to make money, right? Unfortunately, many small business owners take this too literally—and too liberally.

You do need to invest upfront, but you must base investment decisions on objective facts and sound judgment, not impulse or emotion.

When you start out, don’t splurge on fancy equipment, too much inventory or non-essentials. A lot of successful small businesses start at home or online. These cost-effective solutions don’t undermine the validity of your business. Rather, they start you on a smart and frugal financial path that is more sustainable for the future.

Always think of expenses in terms of future revenue. You have to have some money coming in if you’re going to continue to grow. Complete realistic sales forecasts based on historical data from similar businesses (not best-case scenarios) or seek out a mentor from within your industry. While your estimates may not be perfect (at first), forecasting based on real numbers rather than optimistic predictions will put you on better ground.

Focus on building a good product and a great customer experience. Then, win new business and fulfill it in a careful, measured way.

Expedite Invoicing

If your business is suffering from slow-paying clients, take comfort in the fact that you are in the majority. One survey released by PaySimple found that 80% of small businesses receive payments past their due dates.

So, while it’s not necessarily your fault that you’re getting paid late, unpaid invoices are going to kill your cash flow.

Find ways to expedite your invoicing processes. Before you acquire your first customer, write out a clear contract with set timelines and policies for past-due receivables. Then, stick to your guns. Clients need to know that they’ll hear from you the moment a payment is late.

Send invoices right away—the faster you invoice, the faster you’ll get paid. Since most invoicing is done electronically now, this is easy! You can set up automatic email reminders for late payments, send recurring bills and even accept digital payment. Know your terms and collect as soon as you can.

If you still find that clients are non-responsive, try incentivizing before you try penalizing. Getting paid is important, even urgent at times, but the loss of positive rapport with a client is not worth the cost of an early pay day. Offer a 1-5% discount for early payments or, if you can’t afford this kind of cost upfront, consider offering a discount on a future purchase or set up a payment plan.

Prep for Taxes

When you’re a business owner, prepping for taxes is a year round event. Between quarterly payments, sales taxes and ever-changing legislation, you need to be over prepared come April. Don’t fall into the trap of thinking you’ll have enough money when the taxman comes.

Instead, regularly put money aside for your tax bills—and don’t touch it! Clearly label those funds in your accounting software so you don’t overestimate your cash flow. Calculate accurately and plan accordingly.

If there’s room in the budget, reach out to an accountant in order to maximize deductions and stay on top of changes to tax law. If you can’t afford tax advice, it is your responsibility to keep updated books and know your obligations.

Save for a Rainy Day

In both personal and business finances, it’s important to build up an emergency fund. You will have hiccups in cash flow and you need to plan for unanticipated expenses.

Financial advisors recommend building a reserve of two to three months operating expenses. If your company has a zero balance and a low sales month, you could risk not paying employees, missing bills and incurring all kinds of fees. If the emergency well dries up, have a backup lender who knows your circumstances and will help you in a pinch.

Talk to an expert

Getting expert help from an accountant, mentor or other professional will help you avoid common financial pitfalls. Many tax franchises offer free initial consultations, which can give you the personalized advice you need to start off on the right foot.

Successful entrepreneurs are expert risk-takers, but this means they are also likely to make mistakes—and money mistakes can burn the house down. In order to avoid the ashes, you need to be careful and deliberate in your financial decision-making.


About the author

Jaren Nichols

Jaren Nichols is Chief Operating Officer atZipBooks, free accounting software for small businesses. Jaren was previously a Product Manager at Google and holds an MBA from Harvard Business School.

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