Staying Out of Financial Trouble
There are many financial pitfalls an entrepreneur may stumble into on the road to success. Here are three simple rules to live by if you hope to avoid financial difficulties.
1. Vision and Pace
It is a common mistake for upstart entrepreneurs to spend at a faster pace than the company is growing. This is a simple logic: If I invest more in the company, more business will come. Quite often, this is true. In fact it is to be expected. Few companies expect to create a profit in year one. The trick is to find how much debt your company can safely carry as you expand.
For example, if you take a $20,000 small business loan in year one, with a 5% APR over 36 months, you will be responsible for approximately $540 per month. Your projected income must safely absorb this payment into the budget on a monthly basis, while leaving room for plenty of liquid capital as you scale. Initially, your loan payments may comprise 60% of your working budget. However, the goal is to make sure that as your business scales up, your ratio of debt payment to liquid capital in your working budget decreases.
A well executed vision and a steady pace of growth will help you avoid the pitfalls of growing at a rate you cannot afford.
2. Corporate Veil
As discussed previously, the corporate veil is the metaphorical structure that separates the business owner from the business as two separate legal entities. The strength of that veil depends entirely upon the owner’s ability to strengthen the separation.
It is often very tempting to mix personal assets with business. But there are some easy ways to avoid stumbling into this trap. While often times a new business owner has no choice but to use their personal vehicle as their commercial vehicle, make sure to be careful when mixing business with pleasure. If you are going on a personal road-trip, do not use the business card to gain gas points. And do not be tempted into justifying grey purchases like this.
Avoid other grey purchases such as using the business card for meals where no business was discussed, or disguising a family vacation as a business trip to capitalize on flight points.
Though as a business owner the line between your personal life and your business often becomes blurred, make sure that your finances do not. In the case of emergency, protect your personal assets by keeping them separate from the business.
3. Make Wise Budget Decisions
When launching a business it can be quite tempting to want to purchase the office with the best view, or the newest piece of equipment. But in terms of successful financial planning, an entrepreneur must weigh the cost to income ratio of each new purchase in the company.
Many things cannot be easily codified. It is true that ambiance strongly affect sales. Though, this is hard to financially quantify. Therefore, focus on what you can predictably assume. Let us assume we are working with agriculture for a moment.
A brand new tractor will eat a sizeable chunk from your startup capital. However, it is also a vital tool to the success of the company. While you may feel most comfortable with a brand new tractor, a used one may service the job almost as well, at a much lower price point.
Now, you must weigh the factors. Are you skilled with mechanics yourself? Since you’ve chose to operate in this industry, there is a good chance you are skilled. So, if you have the ability to fix a tractor yourself, that will run fairly dependently and achieve the desired goal with excellence, then the smart financial choice is to purchase the used tractor. Since you have the ability to fix it yourself, you do not need to consider the cost of repair. And chances are, you will have the ability to find discounted replacement parts as well.
Consider your skills, and use them to outline your budget. Perhaps you are very skilled with machinery, but do not possess great record keeping skills. The capital you have saved by not purchasing the newest tractor can go towards hiring a new secretary.
In the excitement of opening a new business, it is tempting to overestimate your immediate return on initial investment. You may both hire a secretary and purchase the brand new tractor, but have no remaining capital for emergency repairs or the installation of high-speed-internet.
Before you begin spending money. You must account for the entirety of your capital. Know where your money is going before you begin spending it. If you can resist the temptation to spend unwisely, you will be able to avoid financial ruin.