Four of the Most Common Financial Mistakes Small Businesses Make
(and how to avoid them)
Many small business owners are entrepreneurs who went into business seeking freedom, a better lifestyle, more money or simply because they wanted to run their own show. Financial acumen is rarely high amongst the skills possessed by such people. As such, it is only to be expected that business owners make financial mistakes which can jeopardize their dreams. Here are four of the most common mistakes and how business owners can avoid them.
- Failing to plan
Few small businesses have a working budget and cash flow forecast which is rolled over on (at least) a quarterly basis. As a result, they make decisions based on guesswork and have no idea whether their business’s actual performance is better or worse than what they expected. A solid budget requires the following information, ideally seasonalised and presented on a month by month basis:
- Sales – not just a lump sum figure, but broken down by product or service line and calculated as number of sales multiplied by average sale value
- Variable costs – these are costs that vary with sales and as such, should be driven by your sales forecast
- Fixed costs – unless there are any significant changes, these can be taken from your most recent financial statements and adjusted for any known or expected increases
Once you have developed a budgeted profit and loss account, you should then create a cash flow forecast. This differs from the profit and loss budget because it is looking at the cash inflows and outflows. As such, it needs to take account of how long your customers take to pay you, how quickly you turn over inventory, how quickly you pay your suppliers, any loan repayments due and any forecasted capital expenditure that will not appear in the budget profit and loss account.
For a thorough budget that could be presented to a bank for the purpose of raising finance, you should also complete a budgeted balance sheet.
- Financing capital expenditure out of cash flow
As a general rule, and to the extent that it is possible, it is good practice to cash flow the lifetime of a purchase. By that we mean this: if you are buying stock to sell in the short term, then finance it out of your day to day working capital. But if you are buying a large piece of machinery with a ten year life, then you should look to finance it over ten years. Similarly, don’t fall into the trap of many small business owners where you have a good quarter and go out and buy yourself a flash new car – out of cash flow. Unless you are confident (and have evidence to back it up) that your strong sales will continue, you could find yourself in a cash flow bind if you empty the bank account to buy new assets every time you find you have a bit of surplus cash.
Form a strong relationship with a bank manager and keep them up to date with your plans. Often, the banks will be happy to lend when times are good for your business and you should take advantage of that to properly finance any capital expenditure required to expand your business. Similarly, the best time to secure an overdraft is when you don’t need it. The banks will be more willing and able to help you out and then if you hit a rough patch, you have a safety net.
- Cutting costs rather than driving revenue
When considering how to improve profitability, many business owners resort to hacking at costs. That’s all very well, but there is a finite limit to which expenses can be cut – zero. And then you have no business. On the other hand, the opportunities to grow revenue, assuming you manage your growth within the constraints of your cash flow, are limitless. It comes down to understanding the drivers of revenue, which in most businesses are:
- Number of customers
- Number of times those customers buy from you
- The average sale you make each time a customer buys
Once you understand the drivers, you can put in place strategies to increase each of those critical measures.
Another thing to be aware of when reviewing costs, which, of course, is still a valid strategy, is knowing where to cut. For example, too often businesses cut back on marketing which can often be the last place you should be making cuts. Similarly, a knee jerk reaction to cut back on travel expenses could see an adverse reaction (a recent study conducted by Oxford Economics and commissioned by the US Travel Association found that 57% of businesses surveyed felt that cutting their travel costs during the recession in the US hurt their business.)
- Running your business from a spreadsheet
Quite possibly the most important to avoid of all of the mistakes listed. In this era of Cloud accounting solutions accurate management information integrated with daily bank feeds is readily available. Not to take advantage of such information is to run the business by the seat of your pants. Yet many small businesses persist in keeping their records on a spreadsheet or worse, in a shoe box!
Talk with us today if you feel that your accounting records are inaccurate, unhelpful or obsolete. In fact, we can help you avoid all four of the key financial outlined in this article, helping to set you up for more profitable days ahead.
Here are some general guidelines on what would be a tax deductible expense and a link to the Inland Revenue information on Entertainment Expenses
- Food and drinks are consumed while travelling away on business the expenditure unless the travel is primarily for entertainment purposes, or the entertainment consumed at a social function.
- Food and drink where the employee works overtime
- Food and drink provided as morning or afternoon tea
- Food and drink at a conference, training or event which lasts for at least 4 hours
- Entertainment provided to the public for charitable purposes
- Business lunch with client at restaurant
- Gifts for clients
- Friday night drinks for staff at work premises
- Light working lunches provided to staff at work premises
- End of year Christmas party for staff
Some expenses can be prepaid in March and claimed as a tax deduction in the 2015 tax year, regardless of their amount. These include stationery, postage and courier charges, vehicle registration and road user charges, rates, newspaper subscriptions, and even accounting fees! Other expenses have limits on the extent to which they can be claimed if prepaid. These include rent, consumables (materials used in the manufacture of a product or service), insurance premiums, professional or trade subscriptions, travel, and advertising. The rules around prepayments can be quite complex, so if you’re planning this type of expenditure, please contact me.
To claim a deduction for a bad debt you need to physically write the debt off in your debtors record before 31 March 2015. There should also be evidence that you have taken reasonable steps to recover the debt prior to writing it off.
Any amounts owing to employees at year end (such as holiday pay, bonuses, long service leave, redundancy payments) can be claimed for tax purposes in the 2015 tax year as long as they are paid within 63 days of 31 March 2015.
The book value of assets can be written off for tax purposes if the asset is no longer in use by the business, the business has no intention of using that asset in the future and the cost of disposing that asset is expected to be greater than the proceeds from its sale. Actually, it’s simpler than that. Scan your asset schedule from last year’s accounts and you’ll probably notice assets that no longer exist (for example the mobile phone that you dropped on your driveway and drove over it), or simply don’t work
Facebook celebrated its 10 year birthday last week. Probably what many people want to know is will Facebook be around after another 10 years? In business, if you don't keep abreast of trends and changes in your industry you're actually going backwards and could be left behind!
I was recently talking with a gym owner, and he remarked how people are keeping fit is changing. He noticed that not only were more gyms opening up in his city, but that a number of smaller fitness businesses offering Zumba, Crossfit and Personal training were starting to have an effect on memberships not only in his gym but around the country. His business needed to review its business model and make changes and he was open to suggestions for improvement to his business.
Bringing this closer to home, many business owners have accounting systems that were set up when they first went into business and became a client of XYZ Accountants. At the time this made perfect sense as their accountant was their first point of contact with sorting their taxes out and balancing annual accounts. However, the accounting systems they use have not kept up with the pace of change and the information provided by their accountant is out of date or late. The business owner doesn’t really understand the numbers; the information is used only for tax purposes, and too late to be of any use.
Technology has advanced, the cost of a new accounting system has decreased, and some accounting systems are easier to learn than others. You don’t need to be a technical wizard to use the latest accounting system on your computer, mobile phone or tablet. The information also isn’t stuck on a computer in the back office.. Today you can check who owes you money, what profit you made last month and whether you met your sales target all at the press of a button on your mobile device.
Business owners want clear, up-to-date information to help them make better informed decisions, and not have to wait till the books are done by their accountant. With some, that might require a 3-4 month wait.
At James Burn & Associates we use the latest technology to provide business solutions for our clients. We use the world’s easiest accounting system, Xero, in our practice and work alongside our clients to provide solutions to everyday problems.
The great advantage is that what our clients see on their mobile phones or tablets is what we see. When we see something in the numbers that doesn’t quite make sense we can have a friendly chat with our client and immediately make changes if necessary rather than finding out about it 6 months later! We work in Real Time!
Spring Clean your business
10 Areas of your business you can review right now to improve it.
Cashflow Management (Working Capital)
1. Review your business stock levels and identify slow moving stock or obsolete stock. Have a stock clearance sale to convert slow moving stock into cash that can be reinvested into your business. A large inventory level can tie up valuable cash or working capital. Ideally, stock should be turned over regularly and kept to a minimum to lower the level of cash tied up in stock. You can measure how many times your stock turnsover using a simple calculation:
Cost of Goods Sold divided by Average Stock.
Cost of Goods = Opening Stock + Purchases - Closing Stock
Average Stock = (Opening Stock + Closing Stock) divided by 2.
The higher this number is shows your stock is turning over regularly and for a retail business it is a good sign of a healthy business. However, there are some businesses who sell only a few items of stock a year and other financial calculations may be more appropriate for service based businesses, for example Gross Profit as a % of Sales.
2. Review your work in progress (jobs). How long on average does it take to complete a job? Do I have a workflow management system?
A workflow management system can help you manage your jobs so the work is spread out over the whole year and doesn't all fall due at the same time. It also enables you to highlight which jobs are on track and which ones are falling behind and require further work.
How long does it take me to bill the customer? What are the roadblocks or obstacles that prevent me from being able to bill promptly? A workflow management system can take all of your job information and invoice out of this system straight to the customer. Talk to James about Workflowmax, a job management system that integrates and works well with Xero.
3. Review my accounts receivable (people who owe you money). Are any of the unpaid accounts unlikely to be paid? If the answer is "yes", they need to be written off as bad debts now in your current business year. Check your payment terms. Is there a "gap" between when you receive money from your customers and when you pay out the money to your employees, suppliers and Inland Revenue. Download our free tip sheet on payment terms to see how reducing your payment terms can help you get paid sooner and help you reduce the "gap".
4. Review your business goals set this year for your business. For example, you may have a sales goal as a target. What sales target did you set for your business? Has this been achieved? Why or why not? What marketing tools or techniques have you used to help develop customers and increase sales to your business? Are you able to measure the success of your marketing campaign?
Being able to measure your marketing campaigns will help you to target your marketing or advertising budget effectively and lead to campaigns that give you the best bang for buck. A good exercise is to work out how much sales income a customer will bring over the lifetime of the relationship.
Owner's investment and Capital
5. How much money has been invested by you, in my business this year? What return have you received from your investment? These questions determine if the money you have invested in the business would be better invested elsewhere or help identify what level of return your business needs to achieve to maintain or grow the business. We can help you to maximise your business investment or assist you with selling the business.
6. Are my business cash withdrawals (or drawings) more than the business can sustain? Do you have a personal budget? If you take out more cash than the business can sustain, it is likely you will starve your business of the cash (or lifeblood) that is needed to help maintain or grow the business.
7. Are my business fixed assets (for example: motor vehicle, computer, plant and equipment) capable of meeting all of my current and future business needs? Are there some surplus assets that are no longer used by the business that could be sold to return valuable working capital to the business? When a business has more fixed assets than it needs there is an over investment and this may result in cash being tied up in assets that are not adding value to the business.
8. If you were unable to work tomorrow could the business operate without you? What steps are you taking to enable the business to operate without you? Having a business plan., business operating procedure manuals and trained staff will enable a business to operate without its business owner and allow you time to spend on strategies to boost sales, increase profits and grow your business.
9. Who are your top ten customers? What % of sales does this represent? How can you sell more or repeat business to these customers? Pareto found that 20% of resources employed produced 80% of the income. What is the % in your business?
10. Review your business expenditure. Are there any business expenses that are not adding value to the business? Are there any products or services that you offer that actually cost you money? Using Xero's Dashboard watchlist you can monitor any income or expenditure items to see how they are tracking in relation to a budget.
If you need help with any of the issues I have discussed today please contact me for a free one hour chat to see how we can add value to your business.
The second customer experience concerns a local Stihl shop I have been dealing with. I'll never forget the experience and I highly recommend them. Our lawnmower had died and I was dreading having to replace it.
I did a bit of research and found our local Stihl shop owner Fred very knowledgeable about lawnmowers. We talked about size of lawn v size of engine, getting one that my wife could start easily, mulching v catching. Fred said the mulcher lawnmowers were excellent. Fred also took our old dead lawnmower off our hands and $50 off the purchase price of the new one.
With our old mower we would have had about 3 fadges of grass and this would have cost between $5 and $7 plus the cost of going to the transfer station to dispose.
When you respond to your customers and wow them the result is not only in $$$ in your pocket but also in hundreds of referrals of excellent customer service and, hey, isn't it nice to give someone a reason to feel good about you!
I remember when my daughter Joanna was about 9 months and took her first baby steps. At first she would crawl over to the furniture, and pull herself up. She would often fall but she was so determined to walk that she would try, and try again and she would never give up.
Businesses are a lot like small babies too. Often early on we make mistakes and fall over a bit. Fortunately most of the mistakes we make are not life threatening.
When I started my first business I wrongly assumed that customers would fall in love with the service I provided and all I needed was to advertise in the yellow pages, open an office, and business would just happen.
I learned a lot from that experience.
Many business owners start with a fire in their belly called 'passion'. This is what ignites our dreams to start a new business. Unfortunately it isn't enough to keep the business going and grow from the baby stage to adulthood (maturity)
The key ingredients are having a determination to make things happen and to never give up just like my daughter, Joanna.
This is all about never being afraid to make mistakes and see mistakes and failures as learning opportunities, stepping stones to success.
I mentioned in my last blog about putting feet on the dreams.
In my first business experience although I had a dream of owning my own business I lacked a plan of making it happen. I was waiting for things to happen.
Things don't just happen unless we plan and make it happen. This plan is called a business plan. A business plan at a high level is made up of 4 components.
The vision. This is a picture of the business sometime in the future.
The mission statement. This is the answer to the what question. What does the business need to do to achieve the vision?
The objectives. These provide the answer to "How do I make things happen?"
The values. These are what are is important to the business and shape the actions and behaviour of the business
Without the answers to these key questions, the business will struggle to grow. It could even die.
The next blog will look how vision, mission, objectives and values when linked to business systems provide the source of business growth and success.
The birth of a new business is an exciting time. I can remember when we were expecting our first child. It was a time of great joy and excitement. Our family and friends were really supportive and encouraging. It is also a step into the unknown. I think that is what makes it exciting. James Burn & Associates was birthed about 10 years ago. For many years it was just an idea, a dream of owning my own business that would help other people in business reach their full potential. Dreams remain just that, dreams, until we start to put feet on them. In the next few blogs, I'll talk about how the dream became a reality for me, and how you can apply this to your dreams and seek success in your business.