Few things in life are as exhilarating as starting a business, particularly if you are a young entrepreneur with an exciting business concept and the world at your feet! Many factors go into making a business a success, but one of the most challenging areas, particularly for young entrepreneurs is financial management.
Whether it’s securing capital, separating personal finances from business finances, or managing cash-flow, there are a number of pitfalls that lay in the way of even the most prepared entrepreneur.
Here are some tips for avoiding the most common financial mistakes that young entrepreneurs make.
1. Build a Cash Reserve
A critical decision before embarking on any business venture is having personal cash in reserves. The costs of going into business aren’t always high, but there’s a good chance that you won’t start to make a profit immediately, and you will always need to put cash aside for tax, regardless of your margins.
The following tips from SCORE offer good advice for building a six month cash reserve:
- Add up all your monthly expenses, so you know what your true personal expenses are.
- Still in a day job? Set aside five percent of your net pay each paycheck and build savings.
- Sound like too much? Start with a goal of setting aside $100 week=$5,200 a year, which is a nice cushion.
- As an entrepreneur, you want to be sure that whenever you take a cash draw from the company, you set aside money for tax. Don’t be surprised later with a nasty tax bill.
- Start now. The most important thing is to create a habit of saving each week.
You can also read more from SBA on how to determine when your business will be able to cover all its expenses and begin to make a profit in this guide: Breakeven Analysis: Know When you can Expect a Profit.
2. Consider your Debt-Income Ratio
This is a tricky one for young entrepreneurs, especially if you are paying off student loans or credit card debt. Your chances of getting a business loan are seriously diminished by debt, even if you have the projected income to repay them. If you can, focus your efforts on repaying all your personal debt before you go into business or as early in the business process as you can. Even if you don’t need financing now, you may need capital injection down the line and getting this burden off your back and your personal credit score in check.
3. Don’t Overinvest in your Business
If you are relying on your cash reserves, credit cards, or savings to start a business, try to avoid some of the overinvestment traps that young entrepreneurs fall into – whether it’s a swish office, computer systems, or inventory overload. Focus instead on building a good product and customer experience. Starting a business from home or online are cost-effective ways to avoid some of these pitfalls – these two guides from SBA can help you get started:
One little known option for kitting out your new business is to purchase government surplus products. Just about anything you can think of that your business might need is sold by the government at or below cost, or fair market value.
4. Separate Personal Finances from Business Finances
Keeping your personal and business finances separate, not only provides your business with credibility, it reduces your personal liability (a must if you are incorporating your business as a distinct and separate legal entity under its own name), and helps you manage your taxes, bills and other payments.
While you don’t need a separate business bank account, if you plan on making quarterly estimated tax payments, it’s always useful to have a set-aside business bank account where you deposit a percentage of your income to ensure you can cover your tax obligations. Here are some tips for Selecting the Right Bank for Your Small Business.
5. Talk to a Finance Expert
It’s very easy to cut corners when you are new to business, but getting expert help from an accountant or tax advisor can go a long way to making sure you are in compliance with tax regulations and avoid a common tax mistake – that of paying too much tax!
A consultation with an expert needn’t cost you much. In fact, any tax franchises will offer you an initial consultation and advice for free. This is often all you need to get started, as long as you come prepared with the right questions.
6. Don’t Forget to Pay Yourself a Salary
In the early days it can be very tempting to pour all your profits back into your business without a thought for your own financial needs. But by being sensible and paying yourself a salary based on what you need to keep your own personal finances in shape and separate from your business is essential.
For tips on calculating your own salary read: Paying the Boss – 4 Tips for Setting Your Own Salary.
Caron Beesley has over 15 years of experience working in marketing, with a particular focus on the government sector. Caron is also a small business owner and works with the SBA.gov team to promote essential government resources for entrepreneurs and small businesses.
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