Starting your own business? Be prepared: we find out the five most common financial management mistakes SMBs make.
If you’re starting your own business, chances are you’ve chosen an industry you’re familiar with one where your existing knowledge puts you in a good position for success. But while an understanding of your industry is important, you’ll also need to know what it takes to run a profitable business.
It’s never clearer than at financial year-end how sound financial management underpins all successful ventures, yet it can be a stumbling block for many small business owners. Here are five common financial management mistakes small businesses make and what you can do to avoid them.
1. Your pricing isn’t right
Gavan Ord, business policy adviser at CPA Australia, says not enough small business owners understand the value that they deliver to clients. He recommends setting prices by taking into account the profit you seek from the business, competitor pricing and what customers are willing to pay. “Don’t just follow the prices of your competitors. Who’s to say their prices are right for their business, let alone your business?â€ he says.
“Always seek to maintain your profit margin don’t absorb price rises. Look to pass on your cost increases to customers after first seeking cost savings in the business.â€ Ord also suggests bundling products or services rather than discounting it’s important to place value on your business.
2. You mistake profit for cash
While sales may be increasing, many small businesses struggle because of a lack of cash, says Ord. To avoid this mistake, develop a cash flow forecast to better understand and manage your cash. “Identify when a cash shortfall may occur so you can plan ahead,â€ says Ord.
You can also improve your cash flow by asking customers to agree to payment terms up front. For larger jobs, negotiate with your clients and seek deposits or prepayments based on work completed, or share the risk by negotiating longer payment terms with your suppliers.
Ord also suggests focusing promotional activity on high turnover items that have a good profit margin. “Reduce or remove products or services that have low turnover and low profit margin,â€ he says. “Reduce the stock you hold. However, ensure you carry enough stock to meet customer needs.â€
3. You’re slow to collect debts
You’ve put in all the hard work you deserve to be paid on time! Chasing debt can be a time-consuming task for many small business owners but Ord says it should be a priority. “Put greater energy into collecting debts owed to you quicker,â€ says Ord. “Instead of offering 30 days’ credit to customers, reduce it to 14 days. For debtors that have a history of late payment, contact them before the due date for payment, not just after it. Offer a discount for paying on time or impose interest on late payment. Don’t be afraid to chase up late payers and, if necessary, use debt collectors.â€
4. You don’t understand the components of gross profit
Do you have a good understanding of direct labour costs? Do you measure material waste in your business? Monitoring components of gross profit can help improve productivity. Ord recommends identifying key costs and looking for better ways to manage them. “Set clear targets for business improvement and continually measure actual performance against those targets. Where you are underperforming against targets, take corrective action quickly.â€
5. You lack clear performance metrics
Many small business owners fail to monitor financial and non-financial performance, such as sales per employee or the number of customer complaints. “Identify key areas of your business and evaluate how it is performing in those areas against the goals of the business and against industry averages,â€ says Ord. “Use the evaluation to identify areas of improvement and set targets to improve performance.â€