Advisory Insights – Eight Big Mistakes Made by Small Businesses

By Advisory Practice Lead Robert Wagner and Consulting Executive Aaron Ackerman

Owners and managers of businesses inevitably make mistakes.  It is part of the process of learning to lead an organization, reacting to market events, and working within the constraints of limited resources.  But over the course of working with small businesses for decades, we have seen some clear distinctions between those that thrive and those that struggle.  Listed below (in no particular order) are eight big mistakes that every business owner or manager could avoid:

  • Mistake #1 – Being too optimistic

Business is hard. Period. Too often, however, new businesses or even established businesses that are starting up a new market or service offering overestimate how fast revenues and profits will grow.  The result is usually a huge understatement of the amount of cash needed to support the business.  It is perfectly fine to have an “upside” case to gauge what your business will look like if everything goes perfectly as planned.  But it rarely does, so we recommend to also model your capital needs if it takes six months or longer than expected for revenues to build.

  • Mistake #2 – Failing to define what you do and don’t do

Too often, businesses try to be all things to all potential customers. They try to serve both large and small customers.  They serve customers who are focused primarily on value, as well as customers who are primarily focused on price, often missing the mark on both.  Defining your customer and matching up your products and services to those customers will allow you to develop efficient processes and control costs needed to be competitive and profitable over the long term.

One of our successful clients is a plumbing subcontractor.  Many construction subcontractors are willing to work on any project:  commercial, single family residential, multifamily residential, industrial, etc.  Our client takes a different view, focusing solely on projects with a high density of plumbing in a repeatable application such as military housing, university housing, and high density multifamily apartment complexes.  They have built processes, procedures, and a customized smartphone application around these types of projects in order to control costs and quality.

The challenge of being committed to your defined customers requires you to say “No” from time to time.  In our practice, the most successful clients are willing to refer work to others and keep their focus on serving their best and most profitable customers.

  • Mistake #3 – Lack of focus on the balance sheet

More often than not, when companies reach out to us for CFO services, their company’s problem is on the balance sheet, not the income statement. Many small business owners never even look at their balance sheet, usually because they are not sure what it means.

The balance sheet is the hiding place for future problems, such as unsalable inventory, uncollected customer accounts, an overwhelming debt burden, unpaid and aging vendor obligations, and unfunded bonus or tax payments.  These issues eventually fester into full-blown crises and can take what seemed like a thriving business down within a matter of weeks.

  • Mistake #4 – Failure to fully understand costs

Many business owners fail to include all the costs of their products and services when building their financial models and setting prices. This is particularly true for service- oriented business models.

In a service business, the true cost of delivering the service includes not just the wages and benefits of the service technician, but also the costs of supervision, proposals and estimating, technology, transportation, rework, training (both time and expense), recruiting, professional licensing, and liability insurance.

In our experience, the true cost of labor is often double the hourly wage paid to production and service personnel.  Failure to understand the magnitude of these costs will significantly affect profitability and pricing and could lead to business failure.

  • Mistake #5 – Lack of equity capital

There are two forms of financial capital: debt, which must be repaid with interest, and equity, which does not have to be repaid but eventually expects a much higher return through distributions of future profits and/or eventual sale of the company. Too many business owners do not appreciate the difference between these two sources of capital, which leads to potential trouble as the business begins to grow and more capital is needed.

First, many owners believe debt is easy to get.  It is not, particularly for smaller, less established companies.  Most banks will require both an initial and a secondary source of repayment.  The initial source of repayment will be expected cash flows generated by profits of the business.  The second source of repayment will be potential liquidation of collateral such as the sale of inventory, collection of accounts receivable, or the sale of equipment and real estate.  Many businesses in today’s economy are “asset light,” meaning they lack that secondary source of repayment, particularly capital equipment and real estate that can be pledged to the bank.   In short, although bank debt is relatively inexpensive, not all small businesses will qualify to get all the funds needed to support their growth.

Second, many business owners believe the bank is their “partner” in the same manner as their equity investors.  Bank debt is impatient capital.  The bank wants the debt repaid according to the agreed upon terms.  If a business hits a speed bump such as an unprofitable quarter, a manufacturing problem, or the loss of a key customer, the bank still wants to be paid on time according to terms.  This lack of patience is the direct reflection of the lower cost of the capital.

By understanding these issues at the outset, business owners should work to attract more equity capital by using additional personal assets or taking on investors.

  • Mistake #6 – Not hiring great people (or not letting them do their job)

Great people make the difference in every business. Too often, however, small business owners are reluctant to invest in high quality, experienced talent.  The wisest owners seek leaders who are good cultural fits and who are even more talented than the owners are.  Furthermore, after an appropriate period of orientation and training, wise owners delegate effectively in order to free themselves to focus on improving and growing the business in other areas.  Nothing can help a business make a quantum leap faster and more effectively than a talented and well-run team.

  • Mistake #7 – Lack of processes and procedures

Many business owners started their careers in large organizations and felt bogged down by the myriad of rules and procedures that had to be followed. In fact, many business owners have told us that they started their own businesses specifically to get away from the perceived burden of these processes.

We certainly are not in favor of creating bureaucracies and meaningless forms and processes.  However,   creating and following tailored checklists has been proven to improve quality, efficiency, and the ability to train new staff on company operations.  Like most business issues, there is a right size for every business. The same is true for the creation and adoption of company processes and procedures.

  • Mistake #8 – Ignoring back office functions

Too many business owners attempt to DIY important back office functions for too long. While we understand the need to always keep overhead costs low, the consequences of poor execution of accounting, human resources, and legal functions can be devastating and the costs to remediate a mess are almost always higher than doing it right the first time.

When owners realize they have a problem with their back office function and reach out to us for help, we are conditioned by our experience to warn them that the situation is probably much worse than they realize. We are often confronted with poorly maintained and inaccurate accounting and tax records, large human resource exposures, and poorly drafted or non-existent contractual obligations. In the worst cases, we find unpaid employment taxes, unremitted health insurance premiums, or fraud.

Most back office functions can be purchased on a fractional basis by highly qualified service providers. Creating these relationships early in the company’s growth cycle can avoid many expensive headaches.

We believe the “big mistakes” described above are avoidable.  HoganTaylor Advisory has a strong team of accounting professionals and former CFO’s and bankers to help business owners navigate through these and other issues in order to be free to focus on the profitable growth of their business.