In today's markets, it's tough enough to turn a profit even when you do things right. To avoid making things harder on yourself and putting your business in peril, you need to steer clear of several common financial management mistakes.
Mistake 1: Forgetting that cash is king
Poor cash flow management (or ignoring cash flow altogether) is the quickest and surest way to kill a business, particularly in a fast-growth environment. For that reason, this is the number one financial mistake to avoid.
Watch it like a hawk
In any business, cash is king because once you run out of it, the game is over. So you have to watch cash like a hawk. When the financials come out at the end of the month, most CEOs run to the income statement first. Instead, look at cash before you look at anything else. Attend to your cash flow at all times.
To keep a handle on your cash:
- Review the cash flow statement once a month.
- Look at your receipts and disbursements on a daily basis.
- Know how much cash you have in hand and how long it would last
if the money suddenly stopped coming in.
- Know how much working capital you will need for the next one, three and five years.
First thing each morning, take a quick look at the net receipts and disbursements from the day before and what is planned for the next several days. Such a review will takes less than five minutes, and will immediately either raise red flags or put your mind at ease. This simple exercise, conducted daily, can prevent a lot of trouble!
Mistake 2: Lacking the right mix
Poor cash management will kill you quickly. Over the long haul, the deadliest mistake is failure to get the right mixture of debt and equity in the business.
CEOs commit the debt-to-equity faux pas for various reasons. In some cases, they focus too intently on the short term. In others, they fear taking on too much leverage. More often than not, however, CEOs simply don't take the time to understand their long-term capital needs.
Don't refuse to borrow
Until recently, one of TCii's clients absolutely refused to borrow money. He had always financed the business internally, and insisted that he didn't need any additional money. Fortunately, we kept pushing back, demanding that he prove he wouldn't run out cash. When he couldn't, he reluctantly agreed to open a line of credit. Lo and behold, his business hit a downturn and he needed the money the very next month!
One obvious lesson is that the best time to ask for money is when you don't need it. But there's a much bigger issue here: determining how much debt and equity you should have in the company and what steps you need to take to get the right mix. Remember that having too much debt and not enough equity is also a problem.
Keep the right ratio
The debt/equity mix is crucial. Unfortunately, many business owners stumble in this area when they take equity out of the company in order to protect their investment. They have all their eggs in one basket, and they want to protect some of those eggs by getting them out of the basket.
The need to take some equity off the table is understandable, but continually taking on more debt without adding equity puts you in a precarious position. If you suddenly find yourself strapped for cash – which all growing companies do at one time or another – nobody will lend you money because your debt-to-equity ratio is out of whack.
To overcome this problem, you have to consider bringing in some equity and taking on some additional owners. Yet, in our experience, few businesses even consider this option and fewer still act on it. As a result, businesses limit their growth capability and run a very high risk of bankruptcy.
Other mistakes to avoid
Avoid the top two financial management mistakes described above and you will stay one step ahead of the game. However, don't forget the following potential financial management blunders.
- Failure to plan. The whole point of financial management is to improve the future by taking the right actions today. The starting point for taking the right action is a sound financial plan and a culture of financial discipline.
- Absence of timely and accurate business records. You can't make good financial decisions without accurate and timely information.
- Inability to read and understand financial statements. As CEO, you have to know how to read the balance sheet, income statement and cash flow statement. More important, you have to know what the numbers are telling you. Without these skills, you're flying blind.
- Lack of knowledge regarding costs. The subject of costs is often overlooked, particularly when sales are climbing at a rapid pace. But few things will eat up your cash flow more quickly.
- Failure to renegotiate bank relationships. Don't wait until you are in trouble or ready to expand before renegotiating with your banker. The time to renegotiate and shop around is when the balance sheet looks strong.
- Failure to understand what causes results. What are the real drivers in your business? For example, how do you get sales? Where do your costs come from? What creates the value your customers pay for? Unless you break down the process of how you do business into discrete steps, identify the ones that cause the results and measure them on a regular basis, you will always be wandering in the dark.
- Failure to see the big picture. Ernest Hemingway once wrote about a character who, when asked how he went bankrupt, responded: "A little bit at a time and then all of a sudden."
The last-mentioned mistake – failure to see the big picture – is a financial management error often made by CEOs. Running out of cash is frequently the result. You don't pay attention, you don't see the big picture and the cash dribbles out a little bit at a time. All of a sudden you look up, the cash is gone, your bank is firing you and you're in a total panic.
You must put in place the tools that allow you to see the big picture. Otherwise, you'll end up just like Hemingway's character – but in real life, not in fiction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.