Most small business owners don’t have a financial background. Yet finances are critical to every small business. If for no other reason that we need to create profits to personally earn a living. That is the simplest most urgent need. However, financial information can also be core data that should drive decision-making and highlight pitfalls and opportunities.
Although we may not feel that we are financially savvy, it is critical to understand the basics that can bite hard and create havoc in our business.
1. Not Doing Credit Checks
As a business grows many companies offer to do services or sell products and invoice for them later. They are basically selling on credit. Yet very few small business owners request a credit application or references from new customers. I get it. We are excited for the new customer and we want the revenue. However, if you don’t get paid, it isn’t really revenue. And it is even more crucial if your products or services are high ticket items. If a sale to a customer is $20,000, $40,000 or upwards of $100,000, you are extending a large amount of credit to a customer. It is really important to know if they are worth the credit. In some cases, you are really giving them an unsecured loan for a short period of time. Hopefully, if they pay. So, here are some tips:
- Determine credit limits for different size companies.
- Develop a credit app.
- Request a bank reference and at least two vendors.
- Communicate clearly terms of credit.
2. Allowing Late Payments to Get Out of Hand
All financial software provides standard reports, one of which is an aging of accounts receivable. This is a report you should look at frequently as a small business owner. I would recommend at a minimum 1x per month if all receivables are current. If you are starting to show late payments and growing receivable balances for customers, you need to watch this report weekly. It is best to have a plan for collection in the event that an account goes past due. Here are some suggestions:
- Send out a late notice when the account goes past due and then schedule repeat late notices every 7 days.
- If an account doesn’t pay after the first late notice, call the accounts payable department of the company and ask them if there is an issue and when you can expect a check.
- If you do not receive payment as promised by the accounts payable department, it is now time to get in touch with your customer – the one who made the purchase. Get their help in getting you paid.
It is extremely important for you to not let your receivables for any one customer get significantly past due. It becomes more and more difficult to for them to catch up. Staying on top of it helps you avoid the problem.
3. Ignoring Gross Profit Margins
In the end it is our gross profits that help us pay for our fixed expenses and make a net profit. When we discount our prices too much, it lowers our gross profit. If our variable costs are too high, it lowers our gross profits. Understanding where you should be on your gross profit margin % for a product or service category is the first step in analyzing if your Gross Profit margins are good or bad for a period. Also, understanding the key drivers in your margins, a couple stated above, helps you focus on the most important things to maintain healthy gross profits.
4. Not Establishing Dual Controls
What this basically means is that you must have checks and balances to protect you from any employee doing something unethical i.e. theft. In my career as a business coaches, I have heard more stories of petty theft to significant embezzlement. And, to make matters worse, it is often long-term trusted employees. Don’t take anything for granted. Set-up proper checks and balances to make sure these situations are not possible.
A different person signing checks than the person paying the bills and setting up vendors.
Individual logins to your financial systems and bank accounts. Never give an employee yours.
Check you bank balances regularly and review transactions.
Compare bank balances against what your balance sheet says you should have in your accounts.
Any employee who has a company credit card should provide receipts and what the expense was for on all charges. A manager should approve.
Ask your CPA for other needed areas of dual controls in your business I.e. inventory, payroll, etc.
5. Mis-using your Company Credit Lines
A credit line is usually used for short term purchases while awaiting revenues to come in. The key to not getting in trouble with a credit line is to pay it down frequently. Every time you do get revenue in you should make a payment. Even if you will have to draw again in a few days. The worst thing you can do is to leave a balance on a credit line because you know you will need it again soon. The common error is that we then use the cash flow (because we feel like we have money for a change) to buy other things with it. Soon our balance isn’t coming down and we have used up our cash flow and don’t have the money to pay down our credit line. If you need to keep a balance long term, then you need a different type of loan that is amortized over time and that ensures you make payments on the principal.
There is obviously an unlimited amount of financial management advice that you can receive from your CPA or analysts in your business. However, these 5 are sadly common areas that can seriously cripple a company financially if you are not focusing on them. They may not bite you daily, but when they do, they usually draw blood.