Get Morningstar's essential reading for financial professionals in Advisor Digest. The year 2020 taught us many lessons, and if you were a business owner, you had a front-row seat to the school of hard knocks.
When I look back over the past year, as an accountant and business advisor, I saw many missteps by business owners, some of which threatened the very existence of their companies, made them ineligible for government funding and small business loans, or raised the risks of being audited.
Of course, as a small business owner, you will always make some mistakes. You’re human. The challenge with this aspect of being human is that you may also be the sole person running your business.
But entrepreneurs and small business owners can learn from this crisis, avoid the avoidable mistakes, and be prepared for whenever the next economic shock comes--which it eventually will!
1) Not Keeping Good Business Records
Last year, when the Small Business Administration announced its loans and grants, thousands, if not millions, of business owners missed opportunities to get funding. Why? Because they didn't have adequate bookkeeping records to show they qualified for funding.
Recordkeeping is a pain point for most small business owners. When you’re spending so much time running your business, the critical administrative tasks can get overlooked. But don’t let recordkeeping cost you money.
I remember when I first opened my firm, one of my clients came to me with a bag of receipts and a bunch of illegible notes. I could barely make sense of the mess and almost pulled my hair out trying to prepare his taxes.
Help your accountant help you by maintaining organized business records and sound accounting practices.
Embrace physical and electronic filing systems, save receipts, track your meals with your meeting calendar, account for all taxable income, and document all expenses and deductions. Use apps like Quickbooks to track your financial transactions and Gusto to facilitate payroll.
Stay organized and create recordkeeping systems that help you file your taxes on time. Then you’ll always be ready if an emergency pops up and you need to apply for available funding for your business quickly.
2. Not Having Cash Reserves
Business credit is a hot commodity, but cash is still king.
In 2020, businesses without enough cash on hand for unexpected expenses or their bills when revenue was down were forced to cut back costs and furlough employees. Or worse, they had to close their doors. Unfortunately for them, when the revenue was low or nonexistent, the business bills kept rolling in as usual.
Everyone needs cash reserves for when life happens, even your business. Open a savings account for your business and save in this account often.
I recommend keeping at least 5 times your monthly business expenses in your business savings account. If you’re just starting your business, it may take a while to save this much money, but save anyway. Put a percentage of your revenue in your savings account every time you make money.
3. Not Knowing Your Numbers
Without asking your CPA, do you know if your business is profitable?
Once during a consultation with a potential client, I asked the business owner three simple questions. How much revenue did you make last year? What are you projected to make this year? And how much does it cost to run your business?
Across the table, the business owner just stared at me blankly and said, “I don’t quite know. That’s why I was going to hire you!”
Although hiring an accountant is a significant first step, as a business owner, you must at least understand your numbers at a high level. Your metrics tell you, potential investors, and lenders how well your business performs and how it should perform in the future.
By knowing your numbers in 2020, you had a head start when applying to SBA and Paycheck Protection Program loan applications. This head start could have earned you the additional funding you needed, faster. For the second round of funding for PPP loans, small businesses had to show a 25% reduction in revenue, and without knowing your numbers, you cannot prove this simple requirement.
In addition, last year, if you knew your numbers, you would have been able to get additional funding from banks and other financial institutions if your business had profitable future earnings.
When you understand your revenue and your expenses, you can also make adjustments as the economy changes. I recommend you review your costs at least twice a year and especially at the end of the fiscal year. Figure out which expenses you can eliminate and still efficiently run your company.
Your goal should be to cut expenses without decreasing the quality of your products or services offered to your customers. Always think about ways to improve your business and run it for less.
4. Not Having Multiple Streams of Income
This lesson was probably the greatest lesson of them all! In my firm Cofield Advisors, we work exclusively with creatives in entertainment and music, so as you can imagine, this pandemic was painful for some of our clients.
One of my clients, in particular, couldn’t perform after vendors canceled the concerts and shows that she had lined up. Her income went from six figures to zero in a matter of weeks! Luckily, we had been working on a few other sources of income (online merchandise, courses, e-books, and so on), and these different sources of income were enough to float her through the pandemic. Unfortunately, a lot of others weren’t so fortunate.
I believe every business should have several ways to make money. For example, in my business, I have tax clients, but I also offer online tax education and e-books. My digital products help me connect with more people, have a more significant impact, and earn more money without taking up any time or limited resources. Create several income streams so when one branch of business dries up, another segment can keep the company afloat.
5. Not Saving Enough Money For Tax Bills
I help my clients deduct as many expenses as possible to maximize their business income and minimize their taxes. However, that doesn’t mean you can avoid taxes altogether.
One of the first things I require my clients to do is open separate business savings account for taxes. Unfortunately, many small businesses don’t do this and fail to save for their tax bills. This causes year-round anxiety and massive stress when the tax bill arrives.
I recommend that business owners set aside about 25% of all earnings for taxes throughout the year. The last organization that you want to be indebted to is the IRS!
One final recommendation: Don’t let the fear of this pandemic stop you from building your business. Learn from these lessons, and surround yourself with a strong team that can do the tasks you don’t like to do, don't want to do, or don’t have the skill set for. Build automated business systems that work, and meet with your accountant regularly to stay on top of your business numbers. If you do this, you will be in much better shape whenever the bottom next drops out from under the economy.
Carter Cofield is a certified public accountant who specialized in creatives and entrepreneurs. He’s also the owner of Cofield’s Concepts which is a financial literacy website. The views expressed in this article do not necessarily reflect the views of Morningstar.