Financial Management Mistakes Entrepreneurs Make and How to Avoid Them
Embarking on the entrepreneurial journey is thrilling. You get to be your own boss and bring your ideas to life. However, entrepreneurship comes with major financial challenges.
As a business owner, you need strong financial management skills to achieve success. Without proper money management, many entrepreneurs struggle to keep their heads above water.
According to a U.S. Bank study, 82% of business failures are due to poor cash flow management and financial controls. Clearly, financial management is essential for any entrepreneur.
This guide covers the basic financial management tips entrepreneurs need to manage their finances effectively. Master these skills and you’ll be well on your way to startup success.
- Budgeting – Create a realistic budget to track income and expenses.
- Cash flow – Learn how to manage your cash flow to pay bills on time.
- Financial statements – Use financial statements to understand your company’s performance.
- Forecasting – Make accurate financial forecasts to guide your business decisions.
- Bookkeeping – Keep proper financial records for taxes and business growth planning.
- Emergency funds – Have a contingency for unexpected expenses.
- Credit score – Maintain a high personal credit score to access capital when you need it.
Follow these best practices for managing your finances wisely. Your business success depends on it!
- Budgeting provides visibility into where your money is going. Track real income and expenses against projections.
- Manage cash flow carefully to pay bills on time. Forecast future needs and shortfalls.
- Review financial statements regularly to understand the true health of your business.
- Accounting software and consistent bookkeeping practices are non-negotiable.
- Build an emergency fund with 3-6 months’ worth of operating expenses to weather crises.
- Maintain excellent personal credit to easily access financing when needed.
- Explore your funding options – from bootstrapping to investors – before giving up ownership stakes.
- With solid financial management skills, you can confidently handle the ups and downs of entrepreneurship.
The financial side of running a business can seem daunting. But by mastering the fundamentals, implementing systems, and watching the numbers closely, you set yourself up for sustainable success and growth.
1. Budgeting & Tracking Finances
A budget is the foundation of any good financial management strategy. Budgeting allows entrepreneurs to track where their money is going and make informed decisions. Yet many entrepreneurs fail to invest the time needed to create and manage a budget.
Don’t make this mistake! Budgeting is crucial for entrepreneurs and small businesses. Here’s what you need to know:
Create a Detailed Business Budget
Start by listing all of your expected monthly income and expenses. Be sure to include:
- Revenue from sales and services
- Cost of goods sold – materials, inventory, packaging, etc.
- Operating expenses – salaries, rent, utilities, insurance, etc.
- One-time or variable expenses like equipment purchases or marketing costs
- Loan payments, interest, taxes
- Personal draw – your owner’s salary
Use a budget template to organize this data into a monthly budget. Determine which costs are fixed vs. variable. Be realistic about projected income and expenses.
Once you have a draft, review it with your accountant and make adjustments. Build in a 10-20% buffer for unexpected expenses.
Track Actual Income and Spending
With your budget set, it’s time to track actual cash flow. Use accounting software like QuickBooks or FreshBooks to categorize transactions. Connect bank accounts to automatically import expenses.
Review income and spending weekly. Compare real numbers to your projections. Identify any discrepancies or problem areas.
Leverage Financial Statements
Financial statements like the income statement, balance sheet, and cash flow statement provide visibility into the business. Here’s how entrepreneurs use them:
- The income statement shows revenue, expenses, and profitability over time. Review monthly to make sure income exceeds expenses.
- The balance sheet is a snapshot of assets, liabilities, and equity. Monitor your net worth.
- The cash flow statement tracks actual cash activities. Use it to forecast future cash needs.
Review statements together to get the full financial picture. Compare with budgets and projections.
Use Technology to Streamline
Apps and software make financial management easier. Here are some options:
- Accounting software like QuickBooks tracks all finances in one place.
- Billing and invoicing platforms help manage accounts receivable.
- Expense-tracking apps like Expensify capture purchases on the go.
- Online banking and payments streamline cash flow.
- Payroll solutions like Gusto automates payroll and taxes.
Leverage technology to save time on finances. But always review details manually too.
Create Financial Visibility
With a well-managed budget, up-to-date financial statements, and the right software, you gain visibility into the business. You can:
- Make data-driven decisions on pricing, costs, inventory, hiring, etc.
- Identify issues early and course-correct
- Accurately evaluate business performance
- Spot opportunities for efficiency and growth
Budgeting and tracking finances takes some work upfront. But it pays major dividends through improved financial control and insight.
2. Managing Cash Flow
For entrepreneurs, managing cash flow is a top priority. Cash flow refers to the movement of money in and out of your business. When more money is going out than coming in, you face a cash flow crisis.
Many small businesses fail due to poor cash flow management. Don’t let yours be one of them! Implement these best practices to take control of your finances:
Understand Your Cash Flow Cycle
Start by mapping your complete cash flow cycle from end-to-end.
- It begins when you purchase inventory and materials.
- Next, you sell goods or services and invoice clients.
- Invoices are collected, depositing revenue into your accounts.
- Finally, you pay outstanding operating expenses.
Identify delays between invoicing and collecting payments. Look for ways to shorten this cash conversion cycle. For example:
- Offer early payment discounts
- Streamline invoicing with automation
- Shorten payment terms in contracts
Optimizing cash flow improves the availability of funds to reinvest and grow.
Manage Accounts Payable
Accounts payable are your business debts and bills. This includes:
- Invoices from suppliers and vendors
- Rent, utility, and services bills
- Loan and interest payments
Organize payables into a schedule showing due dates and amounts. Pay bills on time to avoid penalties. Take advantage of early payment discounts.
Prioritize payables so that essential expenses like payroll and taxes get paid first. Use available funds strategically.
Manage Accounts Receivable
Accounts receivable are unpaid customer invoices. Effectively managing AR improves cash flow:
- Send invoices immediately upon delivery of products/services
- Follow up on past-due invoices ASAP
- Offer quick online payments and financing options
- Consider third-party AR financing services for faster invoices
The faster you collect from customers, the sooner revenue becomes available cash.
Use Cash Flow Forecasting
Cash flow issues often arise due to poor planning. This is why financial forecasting is so important.
Create cash flow forecasts to estimate future income and expenses. Factor in estimates for:
- Sales forecasts
- Supply purchases
- Staffing costs
- Seasonal fluctuations
- Capital expenditures
Compare projected cash flow to current cash balances. Identify potential future cash shortfalls or surpluses. Take action to address issues before they become real problems.
With diligent cash flow management, you can avoid disruptive shortfalls. Master these fundamentals and your finances will be far healthier.
3. Financial Forecasting
As an entrepreneur, you likely spend a lot of time focused on day-to-day activities like sales, marketing, and operations. But it’s equally important to look to the future when managing your business finances. This is where financial forecasting comes in.
Financial forecasts estimate future income and expenses based on historical data, budgets, and operational plans. Forecasting allows entrepreneurs to:
- Identify potential cash flow issues before they occur
- Make smart plans to improve future financial performance
- Weigh scenarios when making big spending decisions
Let’s explore key types of forecasts entrepreneurs should develop.
A sales forecast estimates future revenue by predicting:
- The volume or quantity of each product/service sold
- The price points or rates to be charged
Base estimates on past sales data, market conditions, and pipelines. Factor in goals for growth. A sales forecast template can help outline the projections.
Update sales forecasts monthly. Review them alongside your sales goals. Adjust strategies as needed to hit targets.
Profit and Loss Forecast
A profit and loss (P&L) forecast predicts your income statement results for future periods. To create one:
- Start with the sales forecast to estimate revenue
- Project costs like materials, payroll, marketing
- Factor in other income like investments
- Calculate gross margin, operating expenses, taxes
- Subtract all expenses from revenue to determine net profit
Compare your forecasted P&L to actual results. Identify opportunities to improve profitability.
Cash Flow Forecast
While the P&L focuses on profitability, the cash flow forecast projects liquid cash available in future periods. It factors in:
- Cash from sales and other revenue
- Outgoing payments for expenses
- Capital purchases and investments
- Loan receipts and payments
If the forecast shows upcoming cash shortfalls, plan to finance or adjust spending accordingly.
Budget vs. Actual Analysis
Once you have actual financial data for a period, compare it back to the forecasts you made. Calculate budget vs. actual variance for:
- Cash balances
Analyze the variances to understand what drove them. Refine your forecasting models going forward.
With experience, your forecasts will become more accurate and valuable for strategic planning. Just remember that forecasts are predictions, not guarantees! Use them to inform good business decisions.
4. Record keeping & Accounting
Proper recordkeeping and accounting are non-negotiable for business success. Failing to track finances in an organized way can lead to major problems down the line.
Follow these tips to set up solid systems for managing your business’s financial information:
Choose an Accounting Method
You’ll need to use either the cash or accrual method for your accounting:
- Cash basis – You record revenue when received and expenses when paid. Simpler but doesn’t match revenue to the period earned.
- Accrual basis – Revenue is recorded when earned, and expenses when incurred. Better for accuracy but more complex.
Talk to your accountant about which method makes sense for your operations and needs.
Organize Your Records
Physical and digital storage both have a role in recordkeeping.
For physical storage:
- Use filing cabinets to store paper receipts, bank statements, etc. Organize files by year and category.
- Post-bound books record transactions in chronological order.
- Store records securely but make them accessible for tax time.
For digital storage:
- Accounting software stores financial transactions online.
- Cloud-based storage keeps important documents accessible.
- Ensure data security with encryption, backups, and permissions.
A records retention policy determines how long to store different types of records.
Leverage Accounting Software
Manual bookkeeping in spreadsheets is tedious and prone to errors. Accounting software helps by:
- Recording income and expenses automatically
- Tracking accounts payable and receivable
- Managing invoices and billing
- Enabling payroll and payments
- Creating financial statements with ease
Leading solutions like QuickBooks Online and Xero also support tax prep and reporting.
Understand the Key Reports
These essential financial reports provide visibility into your operations:
- Income statement – Shows revenues, costs, and profitability over time.
- Balance sheet – Provides a snapshot of assets, liabilities, and equity.
- Cash flow statement – Tracks money coming in and out of the business.
Review reports frequently and compare to projections. Use them to make smart decisions.
Sticking to consistent accounting methods over time allows for benchmarking and trend analysis. If you change approaches, restate past financials for an apples-to-apples comparison.
Build solid financial habits from the start. Then review periodically to ensure your systems scale as the business grows. With a dedication to bookkeeping, you’ll avoid compliance stress and have financial clarity.
5. Building an Emergency Fund
When running a business, unexpected issues arise frequently. A pipe bursts flooding your office. A critical employee has a family emergency and needs to take leave. Your vendor suddenly hikes prices.
Without accessible cash reserves, situations like these can spiral into full-blown crises impacting operations and profitability.
That’s why having an emergency fund is non-negotiable. Follow these tips to build yours:
Calculate Your Ideal Emergency Fund Size
As a rule of thumb, aim to stockpile 3-6 months of operating expenses in your emergency account. To determine the right amount:
- List your fixed monthly costs like rent, utilities, payroll
- Add variable costs like inventory, materials, marketing
- Multiply the total by 3-6 months as a savings goal
It may take time to accumulate this much. Start saving immediately and build towards your target.
Make It a Budget Priority
Treat your emergency fund as a must-pay monthly expense. Build the contribution into your regular budget.
Automate transfers from your business account to the savings account monthly. Start small if needed, then increase once profitability rises.
Consistent savings deposits add up faster than you think!
Keep Funds Accessible But Untouched
Emergency money should be kept in an easily accessible interest-bearing savings account. Don’t invest these vital funds.
Resist the temptation to tap into emergency reserves for minor or non-essential purposes. This money is for true emergencies only.
Know When to Use Your Reserves
Uncertainty is part of entrepreneurship. Your emergency fund allows you to handle challenges from a position of strength.
Use your reserves to stabilize the business in events like:
- Unexpected cash flow shortages
- Covering temporary losses after a setback
- Bridging the gap if a key employee leaves
- Handling emergency repairs or one-time costs
Having emergency savings prevents having to take on expensive debt during crises. It gives you time to correct course.
Replenish After Use
If you do tap your emergency fund, make replenishing it a top priority. Trim expenses where possible and steer extra profits towards savings.
Set a timeline for building reserves back up. For example, aim to restore 50% of used funds within 3 months and 100% within 6 months.
With consistent planning, your business will have a financial safety net to weather any storm. Don’t wait until it’s too late to build your rainy day fund.
6. Managing Personal Credit
As a business owner, you rely heavily on your business credit accounts and score. However, maintaining excellent personal credit should be a priority as well.
Your personal credit history impacts your ability to access important startup financing like business credit cards and loans. Follow these best practices to keep your personal credit strong:
Check Your Credit Reports
The first step is to check your credit reports from Experian, Equifax, and TransUnion. Do this annually to catch any errors or suspicious activity.
Ensure all accounts and balances listed actually belong to you. Dispute any inaccurate or fraudulent data immediately.
Monitoring your reports also protects you from identity theft. Stay vigilant.
Know Your Credit Score
Your credit score is a numeric representation of your creditworthiness ranging from 300-850. Scores above 700 are generally considered excellent.
Check your score frequently to gauge your credit standing. Use free services like Credit Karma to painlessly monitor your score.
Aim to keep your personal score over 700 to ensure easy approval for financing like credit cards and loans.
Pay All Bills on Time
Payment history is the biggest factor impacting your credit score. Pay all personal and business bills on or before the due dates.
Set up autopay for predictable bills like utilities. Use calendar reminders for irregular bills. Just one 30-day late can tank your score.
If money is tight, call providers before missing payments to explain hardship and request extensions. Avoid defaults.
Keep Balances Low
High balances relative to your credit limits (utilization rate) drag down credit scores.
Try to keep revolving card balances under 30% of the credit limit. Pay off in full each month if possible. Limit total inquiries for new credit.
Monitor Your Reports
Even with healthy credit habits, errors can occur in your credit files. That’s why regular monitoring is so important.
- Incorrect personal information
- Accounts that don’t belong to you
- Inaccurate late payments or balances
- Credit checks from unknown sources
Dispute all errors with the credit bureaus promptly to fix your reports. Then verify the changes.
With diligence, you can achieve and maintain prime personal credit as an entrepreneur. This opens up affordable financing options when you need them to grow.
7. Getting Funding & Managing Capital
Ready to grow your business but need a capital infusion? As an entrepreneur, you have several options to obtain financing:
Bootstrapping means relying on your own funds to operate and expand. Ways to bootstrap:
- Reinvest revenue rather than taking an owner’s draw
- Keep overhead low by renting, buying used, etc.
- Barter services with other businesses
- Use discounted tools and resources
- Take advantage of tax deductions and credits
Bootstrapping maintains full ownership control but growth may be slower.
Crowdfunding platforms like Kickstarter and Indiegogo let you raise small investments from a large group of backers. To get funded:
- Create a video “pitch” explaining your concept
- Set reward tier incentives for backers
- Promote the campaign on social media
Crowdfunding works best for concrete products/services with visual appeal.
Traditional business loans allow you to borrow larger lump sums and pay back over time. Financing options include:
- SBA small business loans
- Short-term working capital loans
- Equipment financing
- Commercial real estate loans
- Business lines of credit
Lenders evaluate factors like revenues, credit, and collateral when approving loans. Interest rates and terms vary.
Angel investors offer startup funding in exchange for partial ownership stakes. Typical angel investment size is $25K – $100K.
Connect with individual angels through networking and pitch events. Be prepared to make a strong business case.
Angels offer mentoring but will expect a return – via interest, dividends or equity buyback.
Venture Capital (VC)
VCs are professional early-stage investors who back young companies with high growth potential. Average VC deal sizes are $1-5 million+
VCs get company equity and often take board seats. Competition for VC deals is intense – you need a very strong management team and market opportunity.
Every funding source has tradeoffs. Assess what method aligns best with your needs and willingness to give up control.
Factor in the full costs – like interest, equity sacrificed, etc. Only take on capital when you have a clear plan to generate returns above costs. Stay focused on profitability.
With astute financial planning and management, your startup can grow on its own merits over time. However, occasional capital injections can accelerate success. Just retain as much ownership as possible.
Conclusion – Financial Management for Entrepreneurs
- Financial management is a core entrepreneurial skill. Master it and you secure your business success.
- Implement solid systems for budgeting, cash flow planning, accounting and financial analysis.
- Continuously monitor your finances – income, profitability, spending, reserves.
- Make data-driven decisions to improve efficiency, cut costs, and drive growth.
- Plan for the future through accurate forecasting and scenario planning.
- Keep detailed, organized records for taxes and informed strategy.
- Build a robust emergency fund to weather unpredictable events.
- Mind both your personal and business credit scores.
- Seek smart funding only when needed to accelerate growth.
- With dedication to financial control, your entrepreneurial dreams can thrive and flourish.
The key is consistency. Make financial rigor a daily habit, not a one-off exercise. Your future self will thank you.
Frequently Asked Questions
1. How much should I budget for an emergency fund?
Aim to stockpile 3-6 months worth of operating expenses. This provides a cushion to handle unexpected costs or cash flow disruptions.
2. When should I tap into emergency reserves?
Only use emergency funds for true emergencies – an employee injury, natural disaster, major lawsuit, etc. Avoid temptation to use for minor reasons.
3. What’s the best accounting software for small businesses?
Top solutions like QuickBooks Online and Xero offer small business plans with all the core features you need. Focus on ease of use and automatic syncing with bank accounts.
4. How often should I review financial statements?
Check your income statement, balance sheet and cash flow monthly at minimum. Quarterly is also wise for more detailed review and trend analysis.
5. What personal credit score do lenders look for?
Aim for a personal score over 700 to ensure easy approval for business loans and credit cards. Check your credit reports often.
6. How much equity do investors want?
It depends on the investor and valuation, but 10-40% equity is typical for angel/VC deals. Bootstrap what you can to limit equity sharing.
7. What’s included in a profit and loss forecast?
A P&L forecast estimates future revenue, costs, other income, taxes, and ultimately net profit. Compare to actuals.
8. Should I use the cash or accrual method?
Accrual accounting better matches income/expenses to periods. But cash basis is easier for small businesses. Ask your accountant.
9. How often should I reconcile accounts?
Reconcile bank and credit card statements at least monthly. Doing so frequently catches discrepancies.
Let us know if you have any other financial management questions! Proper finances are key for every entrepreneur.