Five things that every business owner should know to avoid failure.

Starting a business is an exciting venture. Unfortunately, small business failure is all too common. Statistically, 20% of all new businesses fail within their first two years, then 45% of those fail within their next five years, and 65% of the remaining business fail within the subsequent ten years*.

There are many reasons for business failure including: 

• poor research into their respective market
• problems with their business plans, little capital investment
• poor location/internet presence
• poor response to market demands
• expanding too quickly

The common thread to all of these is inadequate management and the biggest reason for these failures. Specifically, most of these failures can be traced to a lack of financial accountability and understanding of the company and its ability to thrive in their respective market.

Being a talented craftsman or a gifted marketer can help with some of these reason above, but does not automatically make a knowledgeable and effective manager. Accounting, also known as the language of business, is not easy and it can make or break your business.

Here are five of the most common mistakes most small businesses make when managing their businesses. 

1. Thinking Profits and Cash Flow are the Same Thing
Most new business owners confuse these two. It's east to think that profitability means there's enough cash to run the business. Unfortunately this isn’t true. Conversely, if there's positive cash flow, the business isn't necessarily profitable. The only way to distinguish between these two is to maintain good accounting records, and understand how to read financial statements. As a non-accountant, it's easy to misunderstand that an expense means cash goes immediately out, and sales means cash comes immediately in. The reality is that in accounting, some expenses aren't immediately settled and sales aren't immediately collected.

Additionally, there is money spent on capital equipment, loan repayments, and payments/distributions to the owner that are NOT considered expenses and do NOT impact profit. They do however have a real impact on the balance in the bank. For this reason, businesses can show a profit, but have no positive cash flow. On the other side, if they're borrowing or receiving investors money, it’s easy to have a positive cash flow, but not be profitable. The accrual rules of accounting can make this even more difficult to understand, for this reason, a good understanding and a competent accountant are important to any business.

In short, management should take the time to understand the financials and invest in a competent accountant. 

2. Not Closing the Books Each Month. 
Appropriate month end close procedures keep the books relevant and increase the accuracy of the financial data. For each month, every purchase and sale must be accurately accounted for in the appropriate period, although this is relatively easy to accomplish, if this is not done on a regular basis, the amount of work to get this data entered and reconciled increases exponentially and the ability to make good and timely decisions is hindered. Utilizing technology to eliminate the human error factor and speed up the recording of these transaction is necessary for any business to have timely and relevant information. Management should utilize their available options for payments and purchases offered by their bank, business credit cards, and online accounts such as PayPal. These usually have the ability to connect directly to the businesses accounting software, making the monthly reconciliation of these transactions seamless. With automation, the month end reconciliations and entries are much easier and can make the production of accurate and timely financial statements much easier. Failing to have a quick and seamless month end close can lead to inaccurate reports and financials that are too out of date to make good financial decisions.

In short, a good monthly close can help to make good timely business decisions based on relevant, accurate, and timely data. 

3. Mixing Business and Personal Finances
For every new business the ownership has a difficult time juggling personal and business expenses. Each business needs a bank account, cash supply, and accounting system. Any funds the owner personally puts in or takes out must be properly documented in the businesses accounting. Having a separate business account that is independent of personal accounts is essential for tax deductions, business financing, and reduces the likelihood of penalties in case of an IRS audit. Blurring the lines between business and personal finances will make accurate accounting impossible, and make the owner and the  business financially vulnerable.

In short, appropriate segregation of personal and business finances keeps the company from being vulnerable. 

4. Forgetting to Record All Transactions
It's important to count all expenses even the small ones. Every transaction, even the smallest ones, must be documented. The best solution is to get a receipt for every purchase, even for purchases made from petty cash. Make notes on the back of the receipts to clarify the purchase details so they can be properly entered into the accounting system, and determine locations to store the receipts before and after they are entered. Using electronic solutions is best especially if these can be uploaded directly into the accounting software. Policies should be established for the process of accounting for every transaction, and will help streamline the processes.  

In short, all transactions should be recorded with good descriptions utilizing automated services as much as possible. 

5. Not Understanding Your Accounting Software
Accounting can be complex. To be successful, most management will need to hire a professional accountant to handle their finances or invest in some business software that can provide clear, concise in-house accounting. Although contracted accounting is a wonderful solution, management still needs to understand their software and accounting processes. 

Since accounting is a complicated and precise process, learning to use the software can be an ongoing challenge. Many of these softwares offer training courses that will enable a better understanding on how to utilize all the features of the software fully, and not get tripped up by common mistakes. 

Even with how robust the training, there are times that a well-trained accountant can not be substituted. When presenting financial statements to bankers, investors, or vendors looking for credit, it's is highly suggested that management engage a professional accountant. This can save many hours of frustration for management, and increases the likelihood of securing the intended goal through well presented and formatted financial statements. 

Preparedness is Key
Failure is not inevitable. A well-planned system and understanding of accounting is a vital step to success. This can eliminate inadequate management eliminating the biggest reason for failure. Specifically, this increases financial accountability and understanding of the company and its ability to thrive in their respective market. It is recommended to decide the accounting direction ahead of time, obtain all the training needed to understand the financial statements, and contract or hire competent accounting professionals to empower management to guide their business with the confidence and knowledge necessary for success and avoid the statistics of failure. 

*U.S. Bureau of Labor Statistics
https://www.investopedia.com/financial-edge/1010/top-6-reasons-new-businesses-fail.aspx