Financing and Capital Markets

10 Mistakes to Avoid when Financing your Business

In business as in life, errors are inevitable — but many are avoidable. How much could your business (and you) gain by not making some of the most common and costly ones? Read on, and learn about ten financing mistakes you don’t have to make.

1. Not enough (or the wrong) financing

It’s important to get enough financing, and the right kind for the specific situation.

Consider a business that used cash on hand to make major capital expenditures. After depleting the firm’s working capital, the business owner approached his bank for a line of credit increase. Doing this exposed the business to unnecessary risk, and resulted in a very poor match for the term of financing needed.

Instead, the business’s financing should have had a term that matched the anticipated life of the item being purchased or financed, and it should have had the financing in place before the purchase. Remember, for purchase of an item that lasts longer than a year, secure a long-term loan, and for an immediate or short-term need, obtain a line of credit.

Inadequate financing is equally problematic. A business can’t function smoothly if it is frequently running short of cash. Be sure to obtain a large enough loan or line of credit when starting a business or expanding it. Likewise, instead of taking too much equity out of the business when it is performing well, retain enough of your earnings to see the company through leaner times.

2.Growth for growth’s sake

Annual sales growth is generally looked on as a sign of success. But what good are sales or increasing the size of your company without increasing accompanying profitability?

Always monitor both sales (top-line) growth as well as profit (bottom-line) growth. If sales growth doesn’t lead to an increase in profits, investigate why. Are margins too narrow? Are new lines of business less profitable than your core? If so, is this a temporary phase or an ongoing problem? If the issue is simply that your company is growing too rapidly and needs more capital to fund growth, find ways to secure capital or be prudent and grow more slowly.

Also, consider bolstering your company’s financial decision-making and monitoring by hiring a chief financial officer (CFO) or other experienced financial executive. Alternatively, think about what you as the business owner could or should do to improve your own financial acumen.

3. Over borrowing

One mistake many businesses — as well as individuals — make is to automatically say yes to the maximum amount of financing available. Being over-leveraged can put your business in a financially precarious position, with a high level of debt service and very little room to maneuver when in need of further financing. If financing is available — but taking it doesn’t make sense for your business — just say no.

4. Not putting yourself in your banker’s shoes

You surely know the perspective you gain on your business by putting yourself in your customers’ shoes. Similarly, think about the insight you’ll gain by seeing your business from your bank’s point of view. By tuning in to the positive signals your bank is looking for as well as the red flags that can stand in the way of successful financing, you can make the most of your potential borrowing power.

Key factors that will impress your bank include good cash flow, a strong balance sheet, sufficient collateral and consistent revenue growth along with a detailed business plan. Provide a good case for how you’ll use the capital, estimate how long it will take to repay it, and show some contingency planning. Details on your business, products, market, and marketing and advertising will also help you to sell your bank on the loan.

5. Overleveraging your own finances

As a business owner, your personal guarantee may be used as a backup source of repayment in the event that the primary collateral — your company’s assets — isn’t enough to cover the loan. Because of that, you could put your business at risk by over-leveraging your own personal finances. Just as taking too much money out of the business when times are good can come back to haunt you, depleting your personal financial resources could be a problem if you should have to play financial backstop for your business.

6. Weak business plan

Not having an effective business plan, or not having one at all, is common. But a plan is essential to articulating how you’ll target your clients, sell your product, and obtain and grow your clients. It should also include detailed balance sheet and income statement projections. And remember, your business plan should be an interactive, living document that has the flexibility to adapt to change.

7. No plan

What’s the worst that could happen? You should know — and be prepared for it. A contingency plan helps you quickly adapt and adjust if something happens (for example, your company’s revenues fall short of projections). Rather than prepare a single annual budget, include a best-case, worstcase, and likely case scenario. Then follow up on your initial projections, and review and revise your business plan as the year unfolds. That way, if things don’t go according to your best-case plan, you’ll already have a back-up in place, and be able to make the necessary cuts — if needed — to retain business profitability or at least limit losses.

8. Taking your eyes off the ball

You may think everything is fine, with all systems go and on autopilot, but if you don’t routinely monitor your business’s monthly finances, you’ll have a difficult time tracking cash flow, sales growth, profitability and other essential business metrics. Stay focused, be engaged and know what’s going on so you can make sound business decisions about your company’s future.

9. Inadequate credit control

Cash flow is the lifeblood of your business. While sales are essential, you also need to maintain control over credit and your accounts receivable. Even if a number of employees are sending out invoices and statements and following up on overdue payments, ultimately one person must adequately monitor and take responsibility for the entire process. Also, make sure that all customers are aware of payment terms and conditions, including the consequences of a late payment, such as interest charges. Remember, the longer that a debt isn’t collected, the less likely it will be collected.

10. Not listening to your trusted advisors

It’s likely you’ve carefully selected your company’s advisors — an accountant, a lawyer, perhaps a sales consultant or management consultant, a mentor, and your banker. They know your business, and have the experience and knowledge to give you guidance. Talk to them, and take their advice to heart.

Meet with your advisors individually or as a group on a regular basis. You could invite them to sit at the table when you consider and make key decisions. Be sure to listen closely, especially when they disagree with you.

10A. Not questioning your trusted advisors

Everyone can make mistakes, even your accountant or lawyer. When engaging them and listening to their opinions and insights, be ready to question them. If someone or something doesn’t sound right or make sense to you, say something. A vigorous discussion could result in a better solution.

This content does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.