It’s no secret that almost 90% of new startups will close relatively early. But what many entrepreneurs do not understand is that in 30% of the cases, shutting down was due to financial mistakes – not a bad quality product, not even the competition, or marketing efforts… but mistakes in managing and handling funds. What are these mistakes?
In the following text, I will present four common financial mistakes that have already led to the closing of hundreds of ventures, in the hope that you will identify your organization’s failure points and find a solution in time.
Financial mistake 1: Confusing Earnings and Investment with Profits
This is such an apparently elemental mistake but one that is surprisingly made by many. To grow and not just survive, a business must
generate profits. And this is where it is important to emphasize the difference: an investment does not constitute a profit. The purpose of an investment is to develop a product or service, which in turn will lead to revenue. But revenues are not profits either. Salaries, rent, equipment, taxes must all be deducted from revenues. Profit is the amount remaining after all the deductions were made from the revenue.
The solution: Very close tracking of revenue versus expenses. Many entrepreneurs know “roughly” what comes in and what comes out. This it is not enough. Data should be documented on a regular basis, so as to enable making the right business decisions.
Financial mistake 2: Incorrect Burn Rate Calculation
I usually discuss this issue lengthily and extensively, since this is another critical mistake that has led to the closure of many excellent ventures. Burn rate is the financial term referring to the utilization of investments and budgets. Many startups around the world and in Israel are doing their job in good faith, but one morning they discover that they have been left without funds. Why? They did not carry out accurate planning and monitoring of the money spent.
A quality CFO knows this is one of the first things to do as soon as you make an investment: calculating how much operating the organization should cost over time, and then make recommendations to the CEO accordingly. This calculation must include everything, salaries, rent, equipment, licenses, even purchases for the coffee station. This is how long-term growth can be planned. This leads us to the next common mistake…
Financial mistake 3: Treat Money Management as an Additional Task
Over the years I have seen a lot of startups that their money management is carried out by the CEO, VP of Marketing or Business Development, by the Office Manager… These are undoubtedly high quality and intelligent people. But treating money management as a side-task by non-professionals is a serious mistake. Proper money management is a profession that requires both knowledge and experience. Furthermore, a business can only exist because of money which comes in and is managed properly. Assigning one of the most critical areas of an organization to a person who is not a professional in this task may lead to countless failures which in turn may lead to the closure of the venture.
In this case, the solution is simple: hiring a CFO, or at least a financial advisor, to help manage your money and cash flow.
Financial mistake 4: Failing to Plan for Difficult Times
Even if the business is thriving, it shows profits, investors are satisfied and the venture is growing – there will come a day when a slowdown, and even losses, will occur. This is because business is a part of life, where there are always ups and downs. In fact, few companies enjoy steady growth over the years. There are almost always ups and downs.
The secret to success in this case is to accept the possibility that sometime in the future there may be difficult days, and to prepare for them in advance. Prepare yourself a plan to help you survive difficult times: What expenses can be cut quickly? Which departments can be streamlined? Whenever possible, create an emergency fund where you will deposit a little each month so that you will have financial reserves. If you do it properly, the difficult period will pass quickly, leaving no irreversible damage, and even strengthening your venture.
Aviram Arviv is a financial expert and CEO of DANOY: Business Financial Solutions.