The Covid-19 pandemic has seen a mushrooming of businesses as people find an alternative way to find income in tough times. However, do you know that about 20 per cent of new businesses do not live to see their second anniversary? And that one of the leading cause for this is improper money management? What are the things to watch out for?
1. Blowing money on non-essentials
Every expense or purchase in a small business should have a return on investment. Starting a business is exciting and you may find yourself itching to splurge on everything. The list of unnecessary and wasteful spending is long but the most common are:
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· Bad advertising. This is the worst offender. The only thing worse than not spending any money on ads, is paying huge sums for bad and ineffective advertising. Bus and billboard ads, constructed in traditional ego-stroking manner, are just a money pit. It is better to use social media advertising like Facebook or Instagram ads to begin with then advance to other expensive methods as your business grows.
“You will likely not have a budget for a marketing campaign so make sure all your clients are your ambassadors,” says Karanja Kiniaru, owner of Obibee Enterprises who has been in business for eight years.
· Excessive tools and equipment. You can’t operate any business efficiently without computers but a lot of software is online and sometimes free. You don’t need the latest version of MacBook Pro to access the internet, use whatever computer you have.
· Unnecessary staff. Each single position in a small business, including the owner, should generate more money than it costs. Hiring somebody to answer just 10 phone calls a day because you will feel lonely, is wasteful. In line with that, do not hire expensive staff whose salaries will leave a dent in your bank balance.
2. The familiarity trap
Just look at Robert Kiyosaki, author of the ‘Rich Dad, Poor Dad’ bestseller. One of his businesses might have declared bankruptcy, but the rest of his personal and business empire is safe. He has a net worth of $80 million as of 2020.
As soon as your business is set up, you’ll need to open a bank account specifically for your business. You have to develop the mindset that it is an entity that is separate from you. Any money earned by the business should go to the business first, not to you.
However, it’s important you never use your personal accounts or funds for business transactions, and vice versa. If you need to put money into your business in order to meet expenses, and this is crucial, you have to deposit it into your business account first. Why is all this necessary?
Failing to separate business and personal expenses could lead to business cash flow issues and monetary complications pertaining to balancing accounts, measuring profits, filing taxes and setting clear financial goals. Moreover, you will need the protection that comes when and if the law comes for you.
3. The pricing trap
Small businesses often over-value or under-value their products or services.
First understand the difference between cost-based pricing and value-based pricing before you determine your pricing strategy.
Cost-based pricing considers the cost to produce your product, and then builds in a margin to cover overheads and profit. For example if you are a baker, calculate the price of flour, sugar, eggs and even the electricity used. Then add your profit on top. Make some fabricated calls to your competitors and gather quotes then see if there’s any opportunity to undercut your competition on cost.
Value-based pricing is where you charge a customer based on the value your services are to them. If you’re selling a common item with a lot of competitors, value based pricing will be hard. However, you may charge more, if you have a unique selling point such as a brand name that has a lot of value, you’re the top person in your field or you’ve directly worked with the top person/company in your field.
Focus on areas where you can differentiate your business in the value that it delivers, not the cost. You’ll have deeper pockets and a much more appreciative following for it.
4. Working capital trap
Let’s define working capital. If you take your current assets then subtract your current liabilities, what’s left is essentially your working capital. Current assets include cash, inventory (unsold stock), pre-paid expenses and debtors (customers who haven’t paid you yet). Cash is the most important asset so take good care of it. Current Liabilities include account overdrafts, creditors (suppliers who you haven’t been paid yet) and various forms of debt.
Your goal is to transform inventories and receivables to cash as quick as possible which means understanding the time required for a product to be produced or purchased, then sold, profits collected, and money transferred to the bank. This is called the business cycle.
So what exactly is the working capital trap? It is when you are trying to grow too fast, focusing on making more money instead of providing excellent goods and services, deploying people in wrong areas, and not using their skills, while ignoring managing cash inventories, receivables and payables. Thus your business holds too much inventories, while it pays suppliers before bills become due. As a result your business goes down.
Fix it: Tap into your net profits to cover your ongoing expenses while waiting for your invoices to be paid. Alternatively, access external funding. In case the company cannot find the external sources for additional funding, stop expanding your business.
Understanding your business cycle is not the job of “finance” people, but each small business owner should prepare a cash flow forecast for the current year and update it weekly.