The owner of any online business has only one thing in the front of their mind: profit. While this attitude is understandable, focusing too intently on your business’s profit and loss can sideline some financial considerations that are important to its long-term prosperity.
The biggest financial mistake any start up can make is to focus too intently on the short term. Here are five things to keep in mind with respect to your business’s long-term financial well-being.
Don’t mix personal finance with business
One of the crucial first steps in setting up a business is to find a funding source that is easy to manage. Ideally, this takes the form of a business loan from a bank or financial institution. When that isn’t a possibility, entrepreneurs often turn to the use of personal credit to get their business up and running. While it may seem like a necessity when you’re knocked back for a bank loan, using your personal credit card is unwise.
“Owners that co-mingle personal accounts with business accounts are not really keeping an eye on the ball as far as what they’re spending on the business,” says Karen Koedding, CEO of professional organizing service A Little Elf. “When it comes to repaying business payments made on a personal credit card, it’s hard to know which bank account to use to pay, and how much to pay. So you’re not really keeping a clear delineation between what’s being spent and where your money’s going.”
It’s absolutely essential to be able to clearly see how much you’re spending and what you’re spending it on in the early stages of a business. Mixing professional and personal finances will make this more difficult than it needs to be.
Cash flow is more than profit and loss
Once you’re up and running, it can be tempting to focus solely on the things that affect the flow of money through the business. Although it might seem like the number one priority is to build some momentum, it’s important to understand that the concept of cash flow is much bigger than just profit and loss.
“Most businesses run on what is known as accrual accounting,” says Rhondalynn Korolak, managing director of business coaching firm Imagineering Unlimited. “You get your profit and loss, and it’s kind of a statement of everything that you sold and might collect, and everything that you spent and might spend. It’s a bit confusing to run your business off this statement. Really, [running a business] is about cash flow and cash, and that’s totally different from a profit and loss statement.”
While the profit and loss do provide a good indication of how the business is operating on a day-to-day basis, it doesn’t give a broad enough indication of how successful its overall performance is. For example, a profit and loss statement doesn’t properly take into account the costs required to start the business.
“All of the things that go into the setup of that business have nothing to do with the profit and loss, but they affect the underlying cash flow of the business,” says Korolak.
“What people often do is set up their budget and forecast, and it’s all about what they’re going to make in sales, and how much they’re going to spend to pay for their inventory and to pay for the rent and the wages, but they forget about the hundred thousand that they spent upfront.
“People notice costs, but they forget the impact of those costs is right now. You set up a website, and people have the feeling in their head that they’ve spent $20k to set up a website, and they’re going to use that over a period of time, but the money went out the door today. Today’s money is long gone.”
By not paying enough attention to what’s being actually being spent in getting the business up and running, and failing to account for all of their expenditure, business owners run the risk of setting themselves up for unmanageable debt down the track.
Be realistic about start up costs
One of the simplest mistakes made by many startups is to underestimate how much capital is needed to actually get their operation up and running.
“How much do you really spend to establish your brand?” asks Imagineering Unlimited’s Korolak. “Your letterhead, your business cards. All of that stuff can blow out very, very easily. You get talked into things because people keep telling you to advertise. That’s all well and fine, but only if that brings you customers, and only if you can track it and prove that it made money.”
It’s also a fundamental financial mistake to think that you can save money by doing everything in the business yourself. Owners burdened with every minute detail of their business’s operations are more likely to forget things like tax and marketing, which can become costly if neglected for too long.
“People get into business because they have a passion for some kind of work. They don’t realize that running a business is a whole separate job, whether it’s the marketing, the sales, or the accounting,” says A Little Elf’s Koedding. “There need to be systems set up for those. New business owners often don’t keep track of their hours so they don’t know how much to invoice somebody, they lose receipts so they can’t claim those deductions. They file their taxes late, and then they have to go on payment plans. They pay their credit cards late, and then they have more fees and interest. It’s all tied together.”
It may seem counter-intuitive for a penniless startup to hire a bookkeeper or marketing consultant, but if such things are not your strong suit, doing so will save you money in the long run.
Know when you’re breaking even
There are many key performance indicators involved in creating a startup, but few are more important than the moment you break even. Yet, amidst the panic to get the business generating a healthy turnover, entrepreneurs sometimes neglect to pinpoint the moment they actually start making money.
“They know what their profit and loss is going to be, they have a sense of how much profit they’ll make, but they cannot tell you which day of the month they stop paying everybody else and start paying themselves, or how many units of coffee they have to sell in their coffee shop in order to break even, and that’s a real problem,” says Imagineering Unlimited’s Korolak.
The problem is that profit doesn’t necessarily mean cash, and cash is essential for the ongoing financial momentum of any business.
“You can make $100,000 worth of profit, and still have no cash flow and go under. Breaking even is something totally different,” she continues. ” The break-even point is how much you really have to sell to cover the basic costs of operating your business.”
If you can’t establish a realistic projection for what a business’s break-even point is before you open your doors, it’s likely that something needs to change in your underlying business model.
Take all precautions
Another downside to focusing on the short-term operations of a new business is that doing so can tend to eclipse important processes like trademarking.
Jai Edwards is the owner and operator of Bar Sushi, a string of rurally-based sushi restaurants. Starting the business with just $20,000, he made the mistake of focusing on the day-to-day operation of his business, and this impacted his finances in a way that he could not have foreseen.
“I opened my first store in March 2009, in Albury,” he says. “At this point, I had very limited access to capital, so was only spending money on items that were going to have a direct impact on bringing in revenue.”
As the business began to gain momentum, Edwards saw the potential for it to be turned into a franchise. He sent off a trademark application, only to discover that an investment capital firm had registered his business name as a trademark just weeks before he had thought to do so himself.
“I could have been blackmailed into changing my name or working with them,” he says. “At the time the business wasn’t worth that much, sot hey could’ve just bulldozed it and done whatever they wanted, really.”
Luckily for him, the investor withdrew their trademark application after receiving a formal legal objection from Edwards. While the exercise meant that his business was now fully eligible to be turned into a franchise, it set him back $12,000 in legal fees – over half of the amount he used to start the business.
The lesson to be taken from his experience is that a new business owner should prepare for their business to be a success beyond the first six months. If you acknowledge that your financial success has as much to do with the past and the future as it does with turning a profit today, your business is much more likely to flourish than flounder in the long term.