Many startups fail before reaching that magic “cash-flow positive” position they have been striving for, despite seemingly reasonable financial projections. A closer analysis often indicates the cause to be a lack of diligence in handling common business finances. These mistakes are usually masked by excuses, like the economy turned on me, or my competitors played dirty.
I found a good summary of the most common mistakes in a classic book by Kelly Clifford, “Profit Rocket,” written primarily to help you on the other side of the equation – skyrocket your profits. I’m sure all you accountants will agree that fixing the mistakes listed here does not require rocket science, but I’ve seen them so often that to be forewarned is to be forearmed:
- Failing to factor in fixed costs when pricing. Don’t forget to add all pesky “overhead” costs, with fixed elements, like rent, insurance, and administration, and variable elements, like delivery, customer support, and commissions. Always use a break-even analysis to measure what volume and price are required to offset total costs.
- Thinking you are profitable once money begins to flow in. Money flowing in has to exceed all costs, including inventory, credit, and your salary, before there is a real profit. Many startups see initial revenue from customers, and love the fast growth, but fail to anticipate the cost of early vendor payments, monthly overhead costs, and later taxes.
- Considering the job done once a client has been invoiced. A startup must ensure that the payments are collected per agreed terms. A required metric is average days to payment compared to expectations. If you expect payment in 30 days, many customers will stretch this period to 45 days or even 90. This difference will kill your profit margin.
- Not paying close enough attention to cash flow. In startups, cash is king. If you fail to pay a cash obligation when it is due, the business is technically insolvent. Insolvency is the primary reason firms go bankrupt, even while making a profit. Entrepreneurs should sign every check and manage cash personally, rather than delegate this task to anyone.
- Not producing and reviewing financial reports regularly. Too many entrepreneurs hate the numbers side of the business, so they assume their accountants will warn them of danger signs. But administrative people rarely see the big picture, which you need for profitability and survival. It’s well worthwhile to learn the basics and use financial reports.
- Not having a budget. A budget is the financial plan and road map to get you from your business plan to profitability. Without a road map, you can be lost and not know it. Make sure you have a budget that is specific, measurable, achievable, realistic, and timed (SMART). Prepare it, update it regularly, and use it.
- Wasting money unnecessarily. Every business ends up buying things they don’t need or paying more than they should, due to lack of attention and lack of negotiation. Review supplier terms regularly, and don’t be afraid to shop around. Take advantage of early payment and volume discounts, where possible
Above all, avoid self-sabotaging behavior that you may not even be aware of, like blaming others rather than taking responsibility for all decisions, or not charging what your product or service is worth, due to lack of current market information or a personal bias.
For example, I find many entrepreneurs are certain they can make a profit on a 20% margin, even though most of their competitors target 60% margins, or even higher. Unless you are a Walmart, with very high volumes and existing infrastructure, you won’t survive for long on a 20% margin.
It’s fair to use your vision, creativity, and innovation to change the world with new and better products and services. But don’t forget that the underlying laws of finance are harder to change, much like the laws of physics, so try not to ignore these basics. In business, when you lose money on every sale, it’s hard to make it up in volume and still be profitable.