Even with a fantastic product, a strong marketing team, and early users, financial mismanagement can swiftly lead to a firm’s demise. In fact, many small firms fail because of a lack of financial knowledge and inadequate cash flow management.
A study by U.S. Bank found that 82% of small businesses that went out of business did so not because of a lack of sales or a failing product, but because of cash flow problems. These financial failures typically do not occur overnight; instead, they can stem from structural problems within a company’s finances that have existed for some time.
As a result, these problems can remain hidden and cause significant damage before they are discovered. By recognizing these financial problems before they cause too much harm, you can save a failing company.
Here are 5 financial problems that can occur in startups and cause significant financial damage before they are discovered.
Blind Spot 1: The Cash Flow Mirage
Many entrepreneurs believe that as long as their company has a good income statement, the company must be doing well. But there is a huge difference between paper profit and cash in the bank.
All your income statement numbers look great for a highly profitable month. Payday is near, and you need to pay your employees their hard-earned wages. However, when the employees expect to receive their cash the same day their work ends, you realize that the revenue your business earned does not necessarily translate to received cash.
This scenario portrays the accrual illusion, and you must recognize the difference between earning and receiving cash.
Actionable Steps to Secure Your Runway
You need to stop living in the accrual illusion by looking at the right metrics and planning ahead.
- Implement weekly cash flow forecasting: In the forecast, make a list of all money that is coming in and going out over a rolling 13-week period and analyze the results.
- The cash flow statement for your business tells us what money is coming in and what money is going out. To ensure your business is surviving each and every day, we can no longer rely on the P&L for management decisions. Focus your business’s attention on the cash flow for your business.
Blind Spot 2: The Co-Mingling Catastrophe
Blurring the lines between personal and business finances is a common mistake that creates immediate operational chaos. To avoid huge accounting errors caused by commingling funds, you must keep these accounts completely separate at all costs.
All personal usage of business funds should be strictly prohibited, and every company purchase must go through a dedicated business checking account.
This can also cause the corporate veil to be pierced by the courts, exposing your personal assets in the event of a lawsuit. You are essentially operating your company as if it were a personal endeavor and risking your personal savings in order to cover the company’s operating expenses.
Immediate Fixes for Complete Financial Separation
Get a handle on your finances NOW before it’s too late, and the problem gets bigger and more unmanageable as your company grows.
- Open a dedicated business checking account and enforce a zero-tolerance policy regarding personal expenditure from it.
- Set up a formal payroll system to pay yourself a salary or draw on your company’s profits.
Blind Spot 3: Relying on Manual Data Entry
Human error can creep in with even the best financial tracking, leading to potentially disastrous financial decisions. Tracking your finances via manual spreadsheets, such as in Excel, is sure to lead to errors such as missing key deductions, losing receipts, and generally incorrect financial information. The volume of transactions will inevitably lead to hours of tiring manual entry.
If you are unsure where to begin your transition away from spreadsheets, reading a comprehensive step-by-step guide on bookkeeping for small businesses will teach you the essential foundations of organizing your finances. Once you understand the basics, there are lots of amazing financial software packages for small businesses these days that automate the process.
Tracking your income and expenditure using a system that automates the bookkeeping for you is far, far better than hours of boring, manual data entry of spending money.
Essential Tech Stack Requirements
Building a financial software stack is essential for founders to eliminate manual busywork and provide their businesses with real-time financials. Before you subscribe to a new platform, take the time to understand the different types of business software available so you can build a tech stack that seamlessly integrates with your daily operations.
Make sure whichever accounting tool you choose includes:
- Direct API integration with business bank accounts for real-time syncing.
- Automated receipt capture and AI-driven expense categorization.
Blind Spot 4: Letting Receivables Gather Dust
Uncollected revenue represents a huge drain on resources, as this “ghost revenue” is provided to customers in an interest-free loan. While this money is stuck in accounts receivable, it severely limits a startup’s ability to fund growth, pay vendors,s and maintain an adequate cash position. A huge backlog of unpaid invoices creates a big bottleneck that can bring a business to a standstill.
The 3-Part Framework for Faster Payments
To prevent this bottleneck, you must establish a system to enforce timely payment. Create a framework of processes that collect payments without offending your customers, while also forcing payment before your hands are tied up in other obligations.
- Switch to milestone-based invoicing: Instead of waiting until the end of the project to receive payment for all of your hard work, start billing for each completed milestone.
- Automated email follow-ups: Set up reminders to pay 3 days prior to the invoice due date, on the invoice due date, and 3 days after the invoice due date.
- Offer instant payment gateways: Include options (like Stripe or ACH links) directly inside the digital invoice.
Blind Spot 5: The “We’ll Figure Out Taxes Later” Mindset
Your inaction and procrastination regarding your taxes will surely be a source of panic when the time finally comes for you to do your taxes. Not only will your lack of organization in planning for your taxes cause you to have to pay more in taxes because you will be unable to write off legitimate business expenses, but you will also have to pay your accountant large sums of money for having to do everything in reverse.
However, by April, the financial trail has gone cold, and trying to reconstruct an entire year of expenses from memory is impossible. Therefore, you will end up paying more in taxes simply because you lacked the organization to claim legitimate deductions.
Monthly Habits that Prevent Tax Season Panic
Set up your business to operate in a tax-compliant manner. Provide yourself with financial comfort by running your business in a manner that is always ready for an audit and puts you in the best position possible to deal with tax season.
- Set up a “month-end close” to finish your financials for the month by the end of the 5th day of the following month.
- Reserve 25% – 30% of all money coming into your business in a very high-yield savings account to cover taxes.
Final Thoughts: Stop Surviving and Start Scaling
Financial clarity leads to confidence. Surviving and accounting errors will not allow for the growth of your startup.
Auditing your financial systems right now, in a timely manner, will ensure that you can grow your startup without the errors causing serious terminal harm to your business. Eliminate these blind spots and begin to scale your business in earnest.
