The Top Six Financial Mistakes Small Business Owners Should Avoid

Do you know what mistakes most small business owners make? Sometimes small business owners have so much going on they aren’t paying attention to their finances. The following article is a summary of an interview on the Small Business Association of Michigan’s Business Next radio program talking about the top six financial mistakes small business owners should avoid. You can listen to the interview here. 

1. They don’t begin with the end in mind. 

   Just like Stephen Covey says in his 7 Habits of Highly Effective People, business owners need to have a vision of where they are going with their company. Most of the time, a small business owner is someone that enjoys doing something and thinks they can do it better than their current employer, so they start their own business. But somewhere along the way they get bogged down in work and forget to think about where they are headed. They have no focus. Having a vision gives focus to your efforts and be it consciously or subconsciously, allows you to move toward your vision.  A great way to do this is with a business plan that actually puts pen to paper and spells out what you expect to make, spend, and invest towards your vision.

2. They don’t have enough cash reserves.

   Most veteran business owners I know like to have a lot of cash reserves available in case they run into a down economy. A cash reserve smoothes out those times when things are slow so that you don’t’ have added debt to keep things going. How much you save in cash reserves depends largely on your comfort level. Dual income households where your spouse has a steady job might need 3 months worth of business expenses. If you’re both self-employed, or your spouse works in your business, you might need 6 months to a year’s worth of expenses. Those same veterans I just mentioned, usually prefer to have 1 to 2 year’s worth of expenses so that they can weather the longer recessions or down business cycles.

3. They don’t pay themselves first.

   Everyone should put money aside every month so they can retire. This is especially important for small business owners because they have a tendency to invest everything in their business. When retirement age comes, they can’t retire.

4. They don’t diversify their investments.

   After you’ve started paying yourself first, and have cash reserves, you need to diversify your investments. What do I mean? Many small business owners invest in things they know because they are comfortable with it. An IT guy might invest his company stock. They work in technology. So the majority of their livelihood comes from that industry. They add risks by investing in the same industry with their portfolios too.

   This reminds me of a client of mine that is a jeweler. Going into a re-balance meeting I wanted to combat the possibility of inflation and was looking for investments he could use. Knowing that he already had a couple hundred thousand in gold inventory, I opted to suggest a Treasury Inflation Protection fund instead. He already had way too much exposure to gold to add more in his portfolio.

5. They don’t have the right amount of insurance coverage for their risk exposures.

   Small business owners usually fall into one of two categories: either they don’t have enough insurance because they are pinching pennies, or they have too much coverage and they are insurance rich and cash poor. The key is to find a balance. You want to have enough coverage, yet also have the ability to increase it as your company grows. Unfortunately, small business owner risk is not limited to insurance for their particular product or service. You have also got to have adequate coverage for health, life, auto, homeowners, disability, and even long-term care. This is where resource partners like the Small Business Association of Michigan can really help. If they can’t help you directly with a resource partner, they more than likely know a member who can.

6. They don’t have an exit plan.

   As I mentioned earlier, one problem that many small business owners have is that they don’t start with the end in mind. This includes selling your business too. If you have a clear vision as to where you want to go, you can make the necessary steps along the way that will put in place buyout opportunities when that time comes.

   The problem is that by the time business owners stop to think about this, it is usually 5 to 10 years out. Then they quickly hire someone that they plan on grooming to be their replacement, and after a little time, realize maybe this isn’t working. Then they hire someone else, but they have less time and therefore less leverage in negotiating a sale. If you could turn back time, you would have structured your business in a way that you had multiple opportunities for replacements and they would have to bid on your business. This all starts with setting up your business in a manner that allows for growth and starts with the end in mind.