Avoid these financial mistakes.

5 Giant Financial Mistakes Startups Make

Posted July 9, 2015 by David Ehrenberg in Running a Business 101
The financial mistakes startups make are plentiful — and can seriously derail a small business.

This is a guest post, reprinted with permission from our friends at Early Growth Financial Services. Founder David Ehrenberg breaks down exactly what you need to ask your accountant, to have a real handle on your company's finances.

Being an entrepreneur requires wearing many hats. Your days are filled with building a product or service, growing your company and achieving your goals - not to mention empowering your teams to stay productive and happy.

Unless you’re a financial whiz, your company’s financial plan can be daunting. As a result, important financial details can fall by the wayside or go drastically south. The financial mistakes startups can make are plentiful, especially around finances. These five are particularly common - and easy to avoid.

Why do businesses need an accountable expense plan?

Get the Guide

Miscalculating (Or Not Calculating) Cash Burn

Your burn rate is the amount of capital you go through every month to keep your business running. If you don’t have a good understanding of your burn rate, you are seriously hindering your ability to achieve your milestones before your money runs out. According to some recent surveys of new business owners, approximately one third admitted to underestimating monthly expenses. Along the same lines, almost 20% of new business owners realized that they didn’t have enough financing. It’s all too easy to miscalculate your operational costs, so initial financial assumptions are often off. Keeping track of all of your startup expenses will minimize these miscalculations.

The first step in managing for cash flow is to create a bottom-up projection, using real-world variables. (see my previous article on Bottom-Up vs Top-Down Forecasting). 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.

Reforecasting is also key. You need to account for both fixed and variable costs and continually make projections that accurately reflect the real state of your business. (For more information about managing your burn rate, see my previous article on how to reduce your startup burn rate.)

Not Completely Understanding Your Marketplace

If you don’t properly understand your market, you may be guilty of mis-pricing your products/services. Don’t merely add your costs and calculate in the margin you’d like to make. Consider your market position and the value of your offering; start with price and work backwards. In your calculations, keep coming back to the marketplace: who is your customer, what need does your product/service fulfill, what do you have to offer, who is your competition, and what trends may affect your market—and how.

Hiring And Expanding Too Quickly

One of the greatest expenses of any company is its people. To keep your costs low, consider ways to save money on staffing. A big mistake many startups 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 also 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 go.

Making Bad Hires

Another key to saving on staffing costs is to hire for potential, as opposed to experience. Don’t waste money hiring experience just for the sake of experience. And, whenever possible, outsource non-core competencies. For example, outsourcing your financial support frees up your time to focus on other aspects of your business. The company you hire will be responsible for making sure that you stay on track and take care of your financial obligations.

(For more startup staffing tips see my previous post on Bootstrapping Your Startup: 3 Staffing Tips.)

Doing Your Own Finances (Without 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. If you don’t yet have a lot of financial activity, you may not yet be in need of CFO services, but, at the very least, you still need some financial support with your day-to-day accounting and bookkeeping. 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!

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.