The 5 Biggest Financial Mistakes Business Owners Make

Research indicates that only 25% of new businesses survive to celebrate their 15th anniversary. Six out of ten businesses close within their first decade, four out of ten shut down within the first five years, and two out of ten-fold within the first two years. 

Most of these new business owners are making at least one common financial error, which causes their businesses to close up shop sooner, often just a few years after starting.

In this blog, we’ll dive into the five biggest mistakes business owners often make that can jeopardize their business’s stability and growth. We’ll also provide practical tips to help you avoid them and build a healthier financial future for your company. 

Let’s get started!

1. Not Understanding the Difference Between Cash and Profits

You won’t believe it, but it’s true: many business owners mistakenly equate cash flow with profit.

Picture this scenario. You run a graphic design agency. You charge $500 per project and $400 on software, freelancers, and other costs. You’re making a $100 profit per project, which seems like a healthy margin on paper.

That’s where things get tricky. Let’s say you secure $50,000 worth of projects in a month. So, naturally, you’d expect $10,000 in profit. Your $40,000 in expenses—freelancer fees, software licenses, and marketing—must be paid immediately. Your clients, however, won’t pay their invoices for another 60 days. If you don’t have access to $40,000 in cash or a credit line to bridge this gap, you won’t be able to meet your financial commitments, even though your business is technically profitable.

This gap reveals a fundamental truth of business: profit reflects your business’s financial performance, while cash, on the other hand, determines your ability to keep operations running day-to-day. To safeguard against cash shortages, consider negotiating shorter payment terms with clients, building a cash reserve, or establishing financing options. 

2. Growing Your Team Too Quickly

Hiring too many employees too soon can drain your resources significantly and lead to challenges that will be difficult to overcome in the long run. Consider this: you expanded your graphic design agency into a full-fledged digital marketing agency and secured a few big clients. You hire several account managers, designers, and copywriters to meet demand. Along with their salaries, you now face increased overhead costs: buying new computers, investing in software subscriptions, and possibly moving to a larger office. If those clients delay payments or the contracts don’t last as expected, you’ll struggle to cover these expenses.

When funds run out, you cannot let employees go either because it will directly impact their livelihood, which, in turn, will hurt your credibility as an employer. 

Instead, adopt a cautious approach. Focus on scaling your team incrementally as your revenue grows steadily. Outsource short-term projects to part-time contractors or freelancers to avoid over-committing. Hire full-time resources only when necessary. 

3. Poor Budgeting or Not Budgeting At All

Without a budget, you’re essentially flying blind. You depend on your bank account balance to decide if you can buy SEO tool suites like Semrush or give bi-annual bonuses to your employees. This reactive approach could quickly lead to overspending and leave you scrambling to cover basic fixed costs like rent or salaries.

Initially, it may seem like you can manage without one. Over time, a lack of planning can lead to unnecessary spending and missed saving opportunities.

A written budget helps keep you focused on your goals and ensures you’re prepared for unexpected expenditures. You can always adjust it as needed, but having a clear financial plan keeps your business on track. 

4. Operating Without a Legal Structure

If you don’t choose a legal structure for your business, it defaults to a sole proprietorship. And that can lead to several issues.

For starters, operating without a formal structure makes your business appear unprofessional. When all legal documents list your personal name and social security number, potential partners and clients might see this as a lack of credibility on your part. This can hurt your chances of building strong relationships with larger companies or gaining trust within your industry.

Another major risk is personal liability. As a sole proprietor, you are fully responsible for any business’s debts or legal problems. For instance, if your company cannot pay off its debts, creditors can pursue your personal assets like your house or savings. In the worst-case scenario, if your business is sued for an accident on your premises, you are personally liable for any resulting costs. Many small companies face legal challenges, so you shouldn’t take this risk lightly.

Lastly, securing financing for your business becomes much more difficult without a legal structure. Banks are wary of lending to sole proprietors because they understand the risks of lending to a company without legal separation. The lender may have little recourse if something goes wrong, like a lawsuit or a debt issue.

So, choose a legal structure (if you haven’t already)!

5. Managing Business Finances Without Experts

At first, you might be able to handle basic accounting and finance independently. But once your financial operations become more complex and your revenue starts seeing a steady upward tick, it’s time to bring professional support to manage your business money. Even if you don’t have a lot of financial activity yet, you’ll still need help with day-to-day accounting and bookkeeping.

You don’t have to hire a full-time CFO or accountant immediately; you can outsource these roles as needed. 

Conclusion

As a business owner, you’re constantly working to grow your company, refine your products or services, and achieve your long-term goals. However, even the most seasoned entrepreneurs can make costly misjudgments when managing their finances. Avoiding the above-mentioned financial mistakes can set your business up for long-term success.