7 Financial Mistakes Startups Make
When you’re an entrepreneur, you’re busy working every day to find your way, build your product/services, grow your company, and achieve your goals. Unless you’re a financial whiz, it’s not always easy to also work out your financial plan and pin down precise numbers—and sometimes important financial details can fall by the wayside. Even if you are a financial whiz, creating a financial plan and managing your finances can be challenging. But it is essential that you understand the importance of accurate financials—both for your own stability and ability to plan, as well as to convince and assure potential investors of the validity of your business.
There are so many financial mistakes that you can make as a start-up. However, once you know the potential missteps, you can take simple steps to avoid them.
Here are the top 8 financial mistakes start-ups make—and how to steer clear:
1. Underestimating costs
While founders remember the obvious expenses, they often forget related items that can quickly add up.
To get an idea of what your costs will be, ask vendors what they’ll charge you initially and what discounts they can offer as you buy in larger amounts. Talk to people in your line of business about what they’re expenses are and what they spent starting out.
It is advised to entrepreneurs to follow the “rule of two.” “Expect everything to take at least twice as long and cost twice as much as you planned”. The exception is revenue. Divide your revenue estimate by two.
Estimating higher costs, lower revenue and a longer time to viability may lead to a sum that might seem intimidating, and you might feel that the bank is more likely to turn you down if you ask for a higher figure. But above all, a banker wants to see a realistic plan.
2. Mispricing products or services
New entrepreneurs often arrive at a price for their product or service by adding up their costs and adding on the margin they think they ought to make. The approach is typically too simplistic and ignores important factors like market position and the real value of your product.
Before putting a price on a new product or service, decide first how you’ll position it. Will you be the low-cost, mass-market provider, create a high-priced premium or niche product, or offer a value product that combines reasonably good quality and a relatively low price?
“Price your product or service at a point that reflects its value”.
3. Miscalculating (or not calculating) your cash burn.
Your burn rate is the amount of capital you go through every month to keep your business running. It’s all too easy to miscalculate your operational costs, so initial financial assumptions are often off. Keeping track of all of your start-up expenses will minimize these miscalculations.
The first step in managing for cash flow is to create a bottom-up projection, using real-world variables. Top-down forecasting can lead entrepreneurs to be overly optimistic about the sales they’ll close and the revenue they’ll earn. Bottom-up forecasting will give you a more realistic (albeit a less inspirational) gauge of how much money you’ll need to get going—and keep going.
4. Miscalculating the break-even point
Entrepreneurs often don’t distinguish between fixed costs, such as rent and utilities, and variable costs such as workers, materials, packing and shipping. As a result, they wrongly assume all their costs will stay steady as their sales grow, and they plan for their profit margin to widen much faster than is realistic.
Use a worksheet, to sort out which costs related to your business are fixed (they stay steady regardless of how much business you do) and which are variable (and will rise as your sales grow). Then make sure the latter increase in step with your sales in any forecasts you make.
5. Hiring and expanding too quickly.
One of the greatest expenses of any company is its people. To keep your costs low, you need to consider ways to save money on staffing. A big mistake many start-ups make is to hire too quickly. Too many employees is a huge drain on your funds.
In addition to the recruitment and salary costs, there are additional physical costs such as a necessarily larger office space, equipment, and supplies. There’s also the psychological cost: what will happen to these people if your company doesn’t grow and you need to lay them off? And don’t forget the all-important reputation cost as well: how will it look to investors and others if you have to disassemble your team? Instead, hire slow as you grow.
6. Doing your own finances (when you have no training).
If you’ve closed a seed round of funding, have a lot of expenses, and/or are earning real revenue, you need a CFO to help you manage your finances on a strategic level. Honestly, it will cost you more in the long run to do your own finances, rather than hiring a professional to help you manage your finances from the get-go.
Note that there is no need to bring a full-time accountant and CFO on staff. If your company is still small, it makes more sense to outsource these functions, getting support on an as-needed basis while simultaneously reducing your cost structure. Just don’t do it yourself!
7. Not budgeting for their own salary/remuneration/ interest on capital.
A common mistake every business do is to not calculate their own salary, Remuneration or interest other than the Profit Share of the individual. According to the Income Tax Act, 1961, even the interest and remuneration are allowed expense for the business to the extent of certain limits.
Entrepreneurs should add a founder’s salary into the financial picture by nine-month mark, even if the business isn’t yet throwing off the cash to pay it.
By adding this number to your data, you get a more honest picture of where you need revenue to get to and when you’ll hit break-even. And it forces you to be honest about the business’s prospects. If you doubt the business can generate enough money to pay the salary you want and think you’re worth, you might be better off starting a different business or doing something else entirely.
No one else would run your business for free, so you shouldn’t, either.
We hope you avoid these mistakes. Tell us what you would like to know on #FinancialFriday next week!