Small business owners—especially those just starting out—have a habit of ignoring detailed accounting, in many cases running the finances of the business in much the same way that they manage their personal checkbook. Unfortunately, such practices can result in nasty surprises later, especially as the business grows. Let’s look at five common mistakes that every small business owner should avoid.
Hopefully, you’re running your business within a legal entity such as an S corporation or an LLC. (If not, make it a point to research business entities as soon as you finish reading this piece.) The advantage of using a legal entity is the protection of your personal assets from any financial or legal liability incurred by the business. However, those legal protections can be significantly diminished or destroyed entirely if you fail to run the business distinct from your personal affairs. The quickest way to accomplish that unfortunate outcome is to commingle personal and business funds.
You should have a separate bank account for the business, first and foremost. Business income and business expenses need to be deposited to and paid from that account. Your personal expenses—your mortgage, your insurance, your groceries, that set of golf clubs you’ve been eyeing—should be paid from your personal account and never the companies. If the business has money available and you want to take funds out to pay for said golf clubs, that’s fine—it is, after all, your business. But take a draw or distribution from the business, deposit it into your personal account, and buy the clubs with your money, not the company’s.
Ignoring Bank Reconciliations
Everybody makes mistakes from time to time. That includes the people who work for your bank and the people who work for your vendors. It can even include people who work for you. Unfortunately, often the only way to catch a miskeyed deposit or a double-charged invoice is to reconcile your bank account. The business owner who “manages” cash by checking his or her current account balance online rather than reconciling is asking for trouble.
In addition to mistakes, there is a danger of outright fraud. If an employee or a third party is stealing from you, that theft may only show up on the bank statement. It’s also important to remember that if you find a bank error, you only have a limited amount of time (typically 60 days from the statement date) to challenge the bank and get your money back.
Failing to Budget
Running any business is a challenge, but new businesses, in particular, are difficult because you’re often having to carefully balance income and expenses. If you are trying to run your business without a budget, you are at best handicapping yourself and at worst setting your business up for failure.
We humans have a habit of making overly optimistic assumptions. If there is anything that business will eventually teach you, it’s that sales are often not quite what you thought they would be, and expenses are usually larger than expected. A budget makes you put your assumptions in writing and then compare them to reality. Budgets also help you “what if” various situations, which is especially important if you are contemplating expanding your business, adding a product or service line, or buying another company.
Finally, if you decide to seek money from lenders or investors, they are going to want to see a budget that looks out at least three years. You can also assume they’re going to look at it closely to ensure that it’s realistic.
P&L vs. Cash Flow
There are three main financial statements used to run a business: the income statement (also called the profit and loss statement or P&L), the balance sheet, and the cash flow statement. Business owners love to look at the P&L, and it is certainly an important management tool—after all, it tells you whether your business is making money.
One of the major killers of small businesses is cash flow, however, and it is a mistake to assume that the P&L represents cash flow. Depending on the nature of your business, it might be pretty close, but in other cases, there can be a serious divergence between the two.
If you sell on credit—which particularly in business-to-business (B2B) operations is about the only way to do things—you face a particularly high risk. The P&L represents the products or services you sold, but just because you sold them doesn’t mean the money has come in yet. Payroll, rent, utilities, insurance, cost of goods, and all those other expenses mean money is rolling out the back door, so if revenue isn’t rolling in the front, there is definite trouble ahead—and that leads us directly to our fifth and final mistake.
Selling can be hard, but collecting the money for what you’ve sold can be even harder. Particularly for the business owner who is out there beating the bushes for sales, accounts receivable can seem like a minor issue not worthy of their attention. But neglecting receivables can kill cash flow, and that in turn can kill your business.
If you don’t like making collection calls, that’s fine, but hire someone who doesn’t mind doing it, and preferably someone with the demeanor (or at least the determination) of a bulldog. Stay on top of your receivables picture, too. If your receivables balance starts to rise, find out why. In addition to total receivables, you should monitor your balances and aging by customer. After all, if one of your customers runs into financial problems, they’re probably not going to announce it to the world, but they very well may start waiting another 15 or 30 or 45 days to pay bills. Catching such problems early is the best way to avoid having to write off a bunch of bad debt later.
By no means are these the only accounting mistakes that can hurt your business, but they can all be avoided through good accounting practices and an attentive owner. If you don’t love accounting, that’s fine, but hire an expert CPA firm who will stay on top of the numbers for you and ensure your business stays healthy.