The #1 Reason Small Businesses Fail (and 6 Methods to Avoid This)
Post #43: If you fail to plan, you plan to fail.
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Did you know that over 50% of small businesses fail within the first five years?
In this newsletter, I’ll explore the most common financial pitfalls of being a small business owner and how to avoid them.
Including these topics:
Some of the common misconceptions about what causes a business to fail
Financial planning mistakes that will break your small business
Recommendations to avoid these mistakes
Additional references to help you on your way to success
Why running a business is like playing 3D Chess
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Some Common Misconceptions
When a small business fails, it is easy for entrepreneurs to blame the competition, a lack of customers, or ineffective marketing.
However, the real culprit is often (statistically speaking) poor financial planning.
Even with a great idea and a passion for the work itself, underestimating the financial realities of running a company can overshadow all else.
How to Avoid Typical Financial Planning Mistakes
If you are a new business owner, the challenge is that you are starting from scratch.
There are so many things to learn, do, plan, and know in order to get your business out of your head and into reality.
These are the most common mistakes made by business owners:
Mistake #1: Underestimating Startup Costs
Many entrepreneurs underestimate the amount of money that it takes to get started and are shocked by unavoidable and unexpected costs.
For example, you may be prepared for certain business expenses as you get started, like a website, a computer, and internet service.
But what about these additional expenses that you may have overlooked?
Licensing Fees
Software Subscriptions
Business Registration Fees
Quarterly Tax Payments
Business Tax Filing Services
These are just a few of the unexpected costs (off the top of my head) that new business owners won’t expect.
Even if you have a Business Plan, you probably didn’t consider everything that you will need to pay for or acquire.
Solution #1: Create a Financial Roadmap
A Financial Roadmap is just how it sounds: a map that follows the road, or pathway to a successful financial future.
To create a Financial Roadmap, you will need to do the following:
Develop a budget.
Forecast your revenue and expenses.
Calculate your break-even point.
Build a contingency plan.
Knowing how much you need to stay profitable prevents surprises.
Mistake #2: Lack of a Cash Flow Plan
Profit is important, but cash flow is king.
Cash flow is another way to describe the cash that is flowing into your bank account.
Even if your business is making sales, delayed payments or high upfront costs can leave you without enough cash to pay bills, rent, suppliers, or employees.
Cash flow mismanagement is one of the leading causes of small business failure.
Solution #2: Manage Your Cash Flow
Without knowing how much money is coming and going, you are flying blind.
But keeping track of your cash flow makes everything transparent.
With good financial management habits, you can:
Run reports that help you make better decisions.
Invest in the future by using profits and savings.
Plan for growth, hiring, and diversification.
Pivot to new opportunities.
Abandon low profit margin ventures.
Experiment with new ideas!
💡 Tip: Learn more about these financial management methods
Mistake #3: Pricing Mistakes
Many new business owners undercharge for their products or services, thinking lower prices will attract more customers.
The problem?
If your pricing doesn’t cover both costs and profit, you’ll struggle to stay afloat.
On the flip side, overpricing without offering enough value can drive customers away.
It’s a delicate balance that takes time to figure out.
Solution #3: Price for Profitability
Just as Goldilocks took the time to choose the options that were “just right” for her, you will need to test the market and do your due diligence to price your products “just right” for your business and your customers.
Matching competitor pricing may be a seemingly safe place to start, but there are better methods to determine what is best for your business.
Be sure that your price is based on your costs, value, and target profit margins. To do this, you need to have enough information about your financial picture to do the math.
And don’t forget to regularly review and adjust prices to stay profitable.
Mistake #4: Mixing Personal and Business Finances
It’s tempting to use personal funds for business expenses, but this can create chaos in accounting, tax reporting, and financial tracking.
Without a clear separation, it becomes difficult to measure your business’s true financial health.
Mixing your personal and business finances is a sure-fire way to:
Get yourself on the ‘naughty list’ with the IRS and end up with a tax audit.
Buy personal items with business income and create confusion about the actual cost of running your business.
Buy business items with personal money and not be able to deduct business expenses from your business income (leading to overpaying your taxes).
Solution #4: Keep Business & Personal Finances Separate
Set up your business with a dedicated business checking account and credit card, and use them for all business purchases.
This separation makes bookkeeping easier, simplifies tax reporting, and gives you a clear picture of your business’s performance.
💡 Tip: Learn more about keeping these accounts separate.
And make sure that you keep receipts separate as well!
In the event of an IRS audit, receipts are your “get out of jail free” card (not literally, but you get my point). Being able to show an auditor that you spent money for a specific business item makes it easier to defend yourself.
Mistake #5: Not Saving for Tax and Compliance Costs
Many new business owners don’t set aside enough money for quarterly estimated tax payments, and end up with large, unexpected tax bills right before they are due.
Additionally, ignoring licensing fees, permits, and other legal compliance requirements can lead to costly penalties and late fees or fines.
Being unprepared to make these payments on time is a headache to avoid.
Solution #5: Set up a Business Savings Account
There are many benefits to having a dedicated business savings account to retain your earnings before taking profits, including:
Being able to pay income taxes on time.
Having an emergency fund for unanticipated expenses.
Covering payroll or other bills when cash flow is below expectations.
Setting your business up to make a strategic move that requires funding.
Needless to say, it’s better to start with a saving account early than to suffer the consequences later.
Mistake #6: Not Having a Financial Safety Net
Many businesses operate on razor-thin margins, relying on immediate revenue to cover expenses.
This is similar to (or worse than) an employee living paycheck-to-paycheck.
When a slow month happens or an unexpected expense arises, the business may not have enough reserves to stay operational.
A lack of financial cushion forces many owners to close shop prematurely.
Solution #6: Monitor & Adjust Regularly
Financial planning isn’t a one-time task; it’s an ongoing process that requires attention to detail and patience.
Review your financials regularly and adjust your strategy as needed.
Without a clear financial plan, even the most promising business can quickly spiral into debt and failure.
Running a Business is Like Playing 3D Chess
It can be complex, but not complicated.
As you get better at the game (by practicing and learning), you will begin to anticipate the moves ahead of time and be more prepared.
Once you have mastered the level you are at, you can grow and expand. And with expansion come new challenges.
Have patience and make the effort to learn more so that you can continue to beat the odds!