Avoid These Financial Pitfalls When Starting a Business
By Ryan Robinson
Updated January 25, 2017
One trait that sharply differentiates the seasoned entrepreneurs from the wantrepreneurs of the world is their willingness to take calculated risks. I've seen this tendency time and time again from the world's top entrepreneurs like Richard Branson, Mark Cuban, and Arianna Huffington.
Entrepreneurs tend to look for every opportunity to push the boundaries and discover new things about both themselves and the industries they care deeply about.
They're excellent problem-solvers, they test their recognized limits, they cross boundaries, and they sail towards uncharted waters. This propensity for risk-taking stems from the entrepreneur’s skewed perception that often equates risk with opportunity.
However, that same willingness to routinely take risks also makes them more likely to make mistakes. And based on my own tumultuous personal experience with growing a side business while working a full-time job, we make mistakes all the time. Indeed, the world's most recognizable entrepreneurs usually had as many failures as successes over the course of their careers.
Some failures and mistakes are minor and can be corrected on the fly. But some—especially those that concern money—can easily burn the house down, so to speak. It's a big reason why the vast majority of startups fail during their first few years of operation. A cash flow that suddenly dries up, a huge unexpected expense, or a rapidly accumulating amount of debt have all been known to bring even the most promising new businesses to their knees.
Based on both my own personal experience and those of other entrepreneurs, here are the biggest financial mistakes new business owners tend to make—and how to avoid them at all costs.
1. Not Having Separate Business and Personal Accounts
There’s no shortcut on this issue. Even if you're striking out on your own as a solopreneur or freelancer, you can't afford to cut corners on keeping your finances separate.
You'll pay the price later—I've learned this lesson myself.
Ignore the call of convenience and commit yourself to creating separate savings, checking and credit card accounts for your business before you begin collecting revenue from paying customers. Doing this right at the beginning will make it much easier to do the accounting for your business, plan for quarterly tax estimates (in the U.S.) and budget for unpredictable months that may lie ahead.
Having separate bank and credit accounts will also allow for a more accurate picture of your business’ financial health by preventing overlap between what you personally earn & spend and what the business is generating & costing on a monthly basis. The IRS also implements very serious rules against the inappropriate personal use of business funds, and you can easily fall into a taxation pit if you’re not careful.
Having separate business and checking accounts will also better shield you from damaging your credit score in the event that your business takes a nosedive in the future.
Most importantly, separating your business and personal accounts promotes a very different psychological way of thinking about how your business factors into your life.
Every dollar your business earns shouldn't go directly to you if you're investing in growing your company and building a stronger future for yourself. Having separate accounts will help keep you from blurring those lines.
2. Immediately Making Big Purchases for the Business
When you start a new business, it’s understandable to want all the best new laptops, a flashy website, trendy office, best-in-class software and highly talented staff to help grow the company.
However, if you’re itching to make major purchases (even if they feel like investments) near the beginning of your business, think these decisions over very carefully. Some expenses like building a website or attending an industry trade show will be mandatory depending upon the type of business you're starting, but you need to always ask yourself if the expense in question is going to help you generate more revenue in the short-term.
Other expenses such as luxurious parties, team-building trips, and frivolous electronics that aren't essential to the growth of your company offer very little value to your bottom line. If you can’t afford a paid subscription to a popular CRM platform, go for a free or less expensive alternative. Make do with the absolute bare minimum. If hiring regular staff is out of reach, look for talented freelancers on platforms like LinkedIn ProFinder or Upwork. Grow your business first and accumulate a higher level of disposable cash before spending on the “nice-to-haves.”
3. Making Large Personal Purchases (Like a Car)
Even if you've separated your personal and business accounts, scenarios often emerge that force you to dip into your personal funds to finance a business need, such as an expansion into a new niche or a marketing campaign that promises to deliver a high return for the company.
During the first year of your business, there are a lot of unknown variables and unexpected learning opportunities that'll come your way. The reality is that you're going to hit roadblocks. You're going to have failures—and some of these may come with a big price tag on them.
If you've rushed out and purchased a car, home or another large personal expense and your business has something unexpected come up that means you won't be able to pay yourself next month, you can't be strapped down with an exorbitant amount of personal expenses. Be as lean as possible in both your business and personal life while growing your new company.
4. Incurring Credit Card Debt With the Expectation of Future Revenue
The tried and true advice to never to count your eggs before they hatch is timeless financial wisdom.
So is the exercise of prudence when it comes to credit cards. While using credit cards responsibly is a normal business practice, it also exposes you to the risk of deep debt if you mismanage your newfound line of credit.
Because credit cards are so convenient to use, many new business owners fail to see that they're compounding their expenses and incurring interest charges every time they use they leverage their credit line and don't pay off the full balance each month.
Many experts consider irresponsible credit card use as the worst financial mistake entrepreneurs make. If you’re looking for convenience, use a debit card instead.
5. Not Saving for Lean Times and Emergencies
From Benjamin Franklin to today’s best finance experts, there's no shortage of people telling you to keep an ample stash of savings at hand for unexpected expenses.
Call it saving for a rainy day, but there will be times when something happens and covering the cost using your credit card is a shortsighted solution that only tends to create more problems down the line. Most financial planners advise entrepreneurs to keep at least three months worth of expenses in an emergency or contingency fund for both their business and their personal expenses.
6. Not Planning for Upcoming Tax Obligations
Different types of businesses have different federal and state tax obligations, which allow governments to finance infrastructure and programs that benefit citizens.
However, back when you were a full-time employee before you started your own business, your employer would give you an easy-to-decipher W2 form every year when it came time to file your income taxes. Now that you're self-employed, you're responsible for taking the initiative and paying your full tax obligations on your own throughout the year.
As a self-employed individual or corporation, you must make quarterly estimated payments to the IRS so that you're not stuck with a massive tax bill come April each year, and calculating these accurately requires some time and effort. Plan accordingly as this is now just a part of being in business for yourself.
7. Not Setting a Clear Budget for Your Business
If worst comes to worst, you may be able to run your business without a clear plan for the future, but you'll have a very hard time succeeding without at least a rough budget to help guide what you can and cannot afford to spend on each month.
As a founder and manager, your job is to steer your new business towards profitability, and you can only do that if you have a carefully planned budget for operational, marketing and other expenses. Having a clear budget increases financial discipline and clarifies the roadmap to business growth.
Master Your Money Matters
It’s far easier to lose money than it is to earn it.
While a single drastic financial decision can cause a business to fail, failure more often than not follows a series of bad decisions and financial mistakes. You can avoid these mistakes by giving more attention to the details of your personal and business cash flow throughout the year.
Plan your budget, track your expenses, save for emergencies, keep the lines between business and personal clear, and always think of expenses in terms of how they'll generate future revenue for the company.
source - thebalance