The early days of any new business are the most exciting.
That’s when entrepreneurial hope springs eternal, when innovation and ideation are most important and when unbounded growth seems just a few sales away. It’s a fun—if somewhat terrifying—time. Many business owners will develop detailed business plans as they launch a new company, often with comprehensive budget projections designed to guide their short- and medium-term strategic decisions
I took a similar approach when I launched a small, Toronto-based construction company before eventually changing gears and opting for a career in accounting. That experience afforded first-hand insights into key responsibilities such as budgeting, cash flow and risk management. It also showed me how easy it would be to (very quickly) make a mess of your company’s finances. That wasn’t the case with my company, thankfully, but I’ve since seen many entrepreneurs fall into familiar traps when it comes to managing their business finances—particularly when it comes to budgeting.
Indeed, understanding how to set a budget, then stick to one while making constant adjustments based on the performance of the business, is a unique skill that can make or break a fledgling entrepreneur’s success. So, how do so many business owners drop the ball on the budget front? Here are some of the most common pitfalls that derail a start-up’s success:
Not setting a budget in the first place—While many entrepreneurs do set budgets as outlined above, based on my experience there are probably an equal number that skip this critical step altogether. The reason is because they typically become overwhelmed by core operational concerns, from attracting new clients to delivering their products or services. Suffice it to say, this is a huge oversight—and one that can potentially impair a business owner’s ability to make sound financial decisions from the outset.
Relying on inaccurate revenue forecasting—Even when they do set out a budget, many entrepreneurs get trapped into what I call ‘Dragon’s Den thinking’. As anyone who’s watched the (admittedly highly dramatized) show—where entrepreneurs pitch their ideas to a panel of ‘Dragons’ who give a thumbs up or down to business ideas—knows, entrepreneurs will often state the size of their overall market, then assume that if they manage to capture just 1 per cent of it, their business will be a success. While that may be true, securing 1 per cent of any market is extremely difficult. Making a single sale is tough enough! It’s common for entrepreneurs to become so entwined in product or service development and delivery, not to mention becoming blinded by emotion—‘Who wouldn’t want to work with my company/buy my product?’—that they fail to make realistic sales predictions. In many cases, that’s because they haven’t done the necessary research to understand realities of their market. Not surprisingly, these owners are blindsided when windfall sales fail to materialize.
A poor understanding of fixed and variable costs—It’s never easy in the early days to predict your exact fixed and variable costs, let alone how they might fluctuate. But this is still an important part of the budgeting process. Often business owners will predict revenue, but fail to account for (or underestimate) various fixed and variable costs. Labour, material costs and taxes tend to be the most commonly underestimated line-items. Because predicting business-related costs is so challenging, be sure to give yourself ample financial flexibility to deal with any unexpected expenses as they arise.
Low-balling labour costs—Another exciting aspect of starting and growing a business is hiring new employees. Shaping an employee culture through key hires is a privilege and responsibility that makes the start-up experience so unique. But start-ups tend to experience higher employee turnover rates than more established businesses—and that gets expensive. Not only do organizations find themselves absorbing costs for recruitment when turnover occurs, they must spend it all over again to find and train new talent. This is even pricier in industries where top performers are scarce and can demand top salaries. Add in situations when enhanced severance payouts come into play, or where an employee’s dismissal results in a lawsuit, and labour-related costs can soon create a heavy financial burden for an otherwise healthy start-up.
Losing sight of cash flow—I’ve saved the most important point for last. Many new CEOs are incredible visionaries with game-changing ideas and the ability to attract and retain indispensable talent. But they have a tough time reading a balance sheet and paying attention to key cash flow metrics. Indeed, many new businesses have been destroyed by a lax awareness and monitoring of cash flow. It’s vital that business owners understand cash inflow and outflows, keep expenses under control—particularly in the start-up phase—and realize that revenue only really counts when it’s in your bank account. Until then, it’s simply a projection, albeit an important one. Having access to financial tools such as a business line of credit can help ease the pressure in those inevitable (and hopefully brief) periods when expenditures exceed income.
Adriano Romeo, Partner