In this blog I list eight common finance mistakes which could be harming your business.
Are you one of the many small business owners or managers who will admit that Finance and Accounting are not your strongest skills?
If so, you may find it very worthwhile to check whether you are making any of these common financial mistakes that could be costing you a fortune.
Finance Mistake 1 - Accepting Losses While Building Your Business
It's conventional wisdom that you will lose money during the early stages of creating a business and that period may last for up to three years.
While it is certainly true that you can have a lot of start-up expenses, you also need to accept that your business is in its infancy and you have to cut your cloth accordingly.
You don't need a £10,000 website when £100 can give you an Internet presence unless you really do believe you are going to be the next Amazon.
In my view, just accepting start-up losses without challenging the idea is a dangerous mind-set to fall into.
It lulls you into a false sense of security:
What if costs are more than you expected?
What if sales are slower to start?
All businesses lose money in the early years don't they?
Can you see that the idea of start-up losses becomes an excuse for poor performance and delays.
It lets you justify continuing with a marketing approach that isn't working. It allows you to accept delays in key projects or may even let you tolerate under-performing staff even though it's pretty clear that they are not going to make the grade.
The problem is that you forecast a loss, you've made a loss so that means that you're on forecast. It makes it look as if you are in control of your business even if under the surface, all kinds of problems are occurring.
Perhaps you are thinking that your bank manager will understand if you need to go back for more money. I doubt it. Even if you get an extra loan you can be sure that the security and guarantees will increase.
Do you remember the Dot.com crashes at the start of the new millennium?
Financiers were throwing crazy cash at anybody with an Internet idea and huge amounts of money were wasted on advertising. But one good thing did come out of it for small businesses.
The popularity of one particular measure - your cash burn.
Your cash burn is the rate at which your start-up business is using up its precious cash resources and it is usually expressed as a number of months you can survive before you have to move from cash consumption to cash generation.
While it is usually applied to new start-ups, it can be used for any business that is losing money and using rather than generating cash. It is a very thought-provoking measure.
One start-up business approached me recently and that one question - "how long can you survive before you use up all your cash?" really focused their minds on generating revenue from the start.
Finance Mistake 2 - Not Knowing How The Business Is Performing
Many small businesses have inadequate financial reporting systems.
They just don't know how the business is performing. They may not even know how much their sales were last week.
But if you don't know your numbers, you can't take the appropriate actions to correct any problems.
And if you are not fixing the problems early while they are small, there's every chance that you could lose a lot of money before you are even aware of the problem.
Several years ago in the West Midlands, there was a government backed scheme to help companies in financial difficulty receive a significant amount of turnaround advice for free. A surprising number of businesses couldn't be helped because the basic financial information wasn't available.
If you don't know where you are, it is difficult to know where you can get to or decide how you are going to get there.
Finance Mistake 3 - Believing That More Sales Means More Profit
Some times it does, sometimes it doesn't.
There is a well known bankers' mantra that you may have heard before:
"Turnover is vanity, profit is sanity but cash is reality"
Don't be fooled by automatically thinking that because your sales and turnover are increasing, your profits are going up as well. Growth can be expensive and without proper accounting controls you may not being doing as well as you think.
Finance Mistake 4 - Not Understanding and Monitoring Your Break Even Point
Break even analysis is the relationship between costs, volume and profit in your business. It is a simple way to estimate the minimum level of sales or sales volume that your business needs to avoid making a loss.
Email me at firstname.lastname@example.org if you'd like some guidance on how to calculate your break even point.
I'm sure you can see how important it is to know your break even point if your business is making a loss. It helps you to see the size of the problem and to find ways to reduce the break even point so that it becomes easier for you to make a profit.
You do that by:
increasing your sales volumes (without cutting price)
increasing your margins per £1 or unit sold
reducing your overheads.
It may not be so obvious that the break even point is still a critical measure if you are making a profit.
That's because you need an early warning of any trading difficulties in the future.
When the business is doing well, and there is some spare cash in the bank, it's very easy to let overheads creep up and your margins to fall, especially if you've cut your prices to bring in extra sales.
If you see your break even point rise to a sales level that makes you feel uncomfortable, it is far better to take early action to reduce it before the business starts to incur losses.
An associated measure is called margin of safety.
This is the ratio of your current sales to your break even point and shows how much in percentage terms sales would have to change by before the business breaks even.
Finance Mistake 5 - Failing To Collect Cash Quickly From Customers
Businesses fail because they've run out of cash and they can't pay their debts.
One of the biggest causes of cash flow problems is not collecting cash owed to you so that you don't have the money to pay your payroll, suppliers and the tax man.
Even if your business is profitable, if you haven't managed to receive money owed from customers, you can't pay it out. That means trouble for you.
This problem is often caused by a combination of:
mindset (they are our customers and we don't want to scare them off),
the lack of a systematised process and
little clear task responsibility for managing credit policies and collectively cash effectively.
Finance Mistake 6 - Not Anticipating Future Cash Requirements
I made the point earlier about how essential cash is to any business. If it doesn't flow in and out evenly over a period, your current bank balance may be significantly different next week, next month or next quarter.
Variations can be particularly significant if you have:
any form of predictable seasonality in your business or
your business deals in large projects with significant stage payments or
you are losing money.
In these situations you will need to formally forecast your cash flow regularly.
This way you can anticipate your peaks and troughs and make any necessary preparations.
Even if it means going to see your bank manager and asking for an increase in facilities, it means that you are acting pro-actively from the expected facts. That's so much better than responding to the phone call when your overdraft limit has been breached from an angry bank manager.
Finance Mistake 7 - Borrowing Too Much
The more you borrow, the more you have to accept external interference in your business and the more you put your business at risk.
If you can, try to avoid or minimise borrowings by delaying unnecessary costs and capital purchases (so that's the Aston Martin pushed back for another year) and look carefully to see what you can do to advance revenue and cash receipts.
Finance Mistake 8 - Investing without a careful assessment of the costs and benefits
Have you made any large scale purchase without looking carefully at how quickly you will recover the money and how much you can expect to gain overall?
Imagine that you are still considering investing in that £10,000 website we talked about earlier?
How much is it going to cost you in maintenance and search optimisation/placement fees? How many orders do you expect to take over the Internet at what value and profit margin? How long will it take to get the original cost back? How certain are you of your forecasts? What can you do to increase the probability of success?
How did you get on?
Admitting to one or two of the finance mistakes isn't too bad especially if you answered "sometimes" rather than "never".
You'll know from your experiences of the other factors that what I've written works so I've given you something to think about which is great. Just stop and consider how you can change.
More than two indicates a lack of financial control in your business that could have a serious effect.
Don't be downhearted if you've gone down the list and admitted that you don't do many of these items as well as you would like. This is a great opportunity to boost your business.
How much do you think these mistakes are costing you per year in lost profits? £10,000? £25,000? As much as £100,000?
It depends on the business but I think you would be surprised just how much you could benefit from stronger financial controls.
There's a strange thing about weak financial controls. (I wrote "funny" at first but there's nothing funny about lack of control over money.)
Even if it didn't cost much last year, it could prove to be a very expensive oversight this year or the next?
A cash crisis and profit squeeze may be just around the corner and if it happens, it will have a dramatic effect on you and your business.
Business owners can ignore money and finance for so long but it you do, it has a nasty habit of becoming the ONLY thing you focus on because you have to so that your business can survive.
I don't mean to scare you but financial control is so important and it's something that many professional accountants don't put enough emphasis on.
I'll assume that you are like most business owners and you don't have a burning fascination in the theory of finance and accounting.
I always think it's odd - having money is exciting, being in debt is scary but the theory of money is considered dull and boring by many.
Financial help can come from a professional
an accountant in practice
a part time Finance Director
- a finance coach who will help you to improve your own skills
a general business adviser like a business coach.
If you decide that you need specialist help that does the work for you, then you need to decide between:
an accountancy firm in practice
a part time Finance Director or
recruiting your own accountant
That last option is going to be the most expensive but your business may be so big (or destined to be so big) that you need your own accountant.
In my experience the common break-point when businesses recruit a top accountant is often around the 50 employee level but if your business is stable, you may be able to stretch it to 100 employees provided you receive the right professional support.
Recruiting an accountant
If you decide to recruit a full time accountant then there are recruitment agencies that specialise in accountants so they can give you a good indication of what you can get for your money. A good accountant is expensive and salaries are high from a very young age because demand often exceeds supply.
More help from your professional accountants
If your business is very small and you intend it to stay small you may be best staying with your current accountancy firm. Most do a good job of the basic compliance work of accounts preparation and tax but some do a better job than others on the more practical financial management side.
I'm sure that you've already experienced the different staff levels working at your accountants so check who is going to do the work (it's best to have the same person each month/quarter) and find out about their qualifications and experience.
Look for an accountant who is interested in your business and want to help. They should all be able to offer monthly or quarterly accounts. Take the opportunity to talk to other clients who receive the service and find out how useful they find it.
Finding a part time Finance Director
If your business is already a significant size (20 people or more), complicated, unpredictable, losing money or growing quickly I recommend that you at least investigate the options offered by someone working as a part time finance director.
These are people who have many years of experience working in industry and commerce at a senior level. They've seen it, done it and now work on a self-employed basis with a small number of clients with whom they spend a few days a month. See Benefits of a Part Time FD for more details.
If you appoint a part time FD, he or she will get to know your business really well and will focus on the business dynamics and in particular the generation of profit and cash.
I can't emphasise how different it is to work with someone like this compared to nearly all firms of accountants. You have to experience it for yourself.
If you want to understand finance better yourself rather than use a "done for you service", you may be interested in a finance coaching service.
This is designed to help improve your knowledge of financial issues and then to apply it in your business.
Conclusion - How Did You Do On The Common Finance Mistakes
If you didn't do very well in the test, you owe it to yourself to at least follow up on one or two of these options.
Even if your firm of accountants says that they offer a "part time finance director" service, I would still recommend that you contact an independent part time FD if your business is a reasonable size.
Just experience the difference in outlook and approach for yourself and decide which meets your needs better.