Five Common Business Financial Mistakes

Wondering about what you need to keep your business healthy? Here are five common financial pitfalls that could harm your business’s financial health.

Not Understanding your Business Numbers

Most of us have had at least one traumatizing math class. For some of us, math anxiety in our youth translates into learned helplessness around numbers as an adult. Business owners must keep their eye on the numbers to be successful, therefore being helpless with numbers is frequently catastrophic if you avoid looking at your financial results and don’t interpret them to drive your future.

There is hope! If a pipe bursts in your home, you probably will not fix it yourself. You hire a professional plumber to repair the break. The same is true for your business’s financial results. You have suppliers, employees and other stakeholders like banks, lenders and government tax authorities that are part of your business’s financial responsibilities. It is your responsibility as a business owner to meet those obligations. Understanding your financial situation is critical. The solution? Find someone who can help you learn and understand. It is your responsibility and learning really isn’t difficult when you choose the right teachers!

Gross Profit is Too Low

Gross Profit Margin is the percentage of revenue a company keeps after deducting the cost of the goods it is selling. Your gross margin must be healthy, because all the other non-direct expenses for a company (payroll, rent, insurance, office supplies, professional services, advertising, IT costs) still must be paid from what remains.

What is a reasonable gross profit margin, then? According to The Business Development Bank of Canada, the financial institution devoted to Canadian entrepreneurs: “On the face of it, a gross profit margin ratio of 50 to 70% would be considered healthy, and it would be for many types of businesses, like retailers, restaurants, manufacturers, and other producers of goods. But for other businesses, like financial institutions, legal firms or other service industry companies, a gross profit margin of 50% might be considered low.”

A 30% gross margin may seem good to you, but if your business has the kind of financial obligations listed above, the cash you need to pay your bills will run out very fast. Anything under 50% simply isn’t good enough. The price you charge is easier to change than the prices your suppliers charge you (although, think about negotiating costs with your suppliers). Often, we hear of clients who are shy about charging too much. Yes, it is important that you not price yourself out of your market – instead, focus on the value of your service or product. You can’t be shy about the survival of your business. Listen to the numbers, especially Gross Profit Margin.

Not Tracking Cash Flow

Cash Flow for a business refers to the movement of money into and out of the company over a specific period. Cash flow is different from Profit. Cash flow encompasses cash receipts from sales, investments, and financing, minus all cash expenses such as payment of operating costs, investments, and debt payments. Positive cash flow ensures liquidity and operational stability. Cash flow is your business’s life blood.

The timing of cash flow is critical to a business. Sales and expenses flow monthly, but businesses face significant expenditures through the year to buy assets or inventory, for example a large insurance “balloon” payment that appears annually, or your federal and provincial taxes. Think about what happens if you are short of cash and you need to both meet payroll and buy inventory in advance of your strongest sales season. Healthy businesses can still hit significant financial draws during the year by being aware and planning for them.

Not Saving for Taxes

A standing recommendation that Guildstreet makes to our clients is that they set aside a percentage of their monthly cash in-flows into a savings account to cover regular sales tax remittances and annual corporate taxes. The minimum to put aside is the percentage of GST/HST/PST that you pay, plus the percentage of income tax that you pay in your jurisdiction. For example, for a small business in Ontario HST is 13%, plus Federal tax of 9% and business tax is 3.2%, or 25% total. This is a form of financial discipline that many business owners find challenging. But you know what Benjamin Franklin said about death and taxes.

Sales taxes – In Canada this is at minimum GST, and then there is HST, and potentially provincial sales taxes as well. Here is an important thing to understand: The cash you collect from customers on sales taxes was never yours to spend. The money you collect on sales taxes is only waiting for the day you remit it to the government. Do not spend this money on anything other than remittance to the applicable government, or else you are involuntarily adding them to your list of creditors. Those levels of government do not appreciate that. They did not agree to be one of your lenders.

Income taxes – If you are not paying your tax accountant for tax planning services, your annual income tax bill may have more variability that you are prepared for. This is another big reason why setting aside a percentage of cash payments is an important proactive tool. Even if you do not save quite enough, your incremental tax payable will be far easier to manage. If you did put aside more than your taxes owing, congratulations, you can use your saved extra cash in your business.

Unnecessary Sales & Discounts

Some merchant advisory services advocate sales/discounts, even on products that have consistent demand at regular prices. Discounts can be a tool to boost visibility of a business’s offerings. But beware! Use this tool cautiously. Be sure that you are not setting yourself up for a financial mistake, for a few big reasons…

1.     You are training your customers to wait for sales, and never pay full price. This will, over time, steadily erode your undiscounted sales, and if you are already selling at a low gross profit, this will likely result in the demise of your business in time.

2.     It makes no logical sense to offer discounts on products that consistently sell at regular price. You may feel that you are overstocked on inventory right now, but steady sales will draw that inventory down. Consider if the cost of that storing that inventory is offset by the loss of revenue from selling at a discount.

3.     You need a much higher sales volume to offset the reduction in revenues resulting in the discount. Consider the following table:

In this example, a 25% increase to sales is required to simply match a 20% reduction price. This example is consistent for all businesses selling any product or service.

When should you use discounts? When you need to move out inventory that is difficult to sell, and that you will never stock again. But then, you might be better off if you sell that old inventory to a reseller.

A better idea to increase sales is to revisit your advertising strategy to boost visibility. Advertising is typically less expensive than discounting in the long run.

Financial business health comes from knowing your numbers – learn your critical financial measures, plan for a realistic gross margin, save for taxes, manage your cash flows, avoid discounting.

Did this article help add a little clarity and guidance to help you steer your business toward financial stability and prosperity.

We can help you learn your numbers and help you keep your business financially healthy.  Contact Guildstreet (info@guildstreet.ca) today.   

Written by Alan Beaulieu