By: Pamela Martinez, JBS Corp.
In May, we released an article that briefly touched upon why a recession can be the best time to start your business. As we continue to fall deeper into the recession, more and more Americans are being laid off or furloughed from their jobs. And collecting unemployment can only provide so much certainty, making this the prime time to turn your hobby into a business!
While there are many inspiring articles and videos out there to encourage you to start your business, we want to take it one step further and not only encourage you to become your own boss but also to highlight some common mistakes that small business owners tend to make
Equity or Debt
More often than not, starting a business cost money. However, you don’t want to get yourself or your business knee-deep in debt before you’ve opened your doors (or webpage). For small business owners, the best option in acquiring funds to grow the business is through the use of debt in the form of personal credit cards/loans, as opposed to Equity, which involves the use of the investors, which essentially become partners in most of the business decision-making. As a first-time small business owner, you’re going to want full flexibility, creativity, and control over your product and your business model.
Comingling of Funds
Comingling funds refers to the use of one’s personal bank account to cover personal and business expenses. For example, if you use your personal bank account to cover the cost of supplies for your woodworking business, you’re comingling your funds.
The comingling of funds is a common mistake many small business owners make, especially in their early stages, simply because they just don’t know better at the time. When starting a new business, best practice is to open a business bank account; this enables you to keep your personal and business spending sperate and also to keep an organized record of where the business money is going.
Not Creating Bookkeeping and Accounting Systems
Bookkeeping and accounting are essential to the success of any and every business. These two systems help keep and maintain financial records/statements organized, which in turn paint a clear picture of how your business is doing—enabling you to visualize growth and where money can be moved around to contribute to the growth. Proper bookkeeping is also necessary for filing state and federal reports, such as income tax returns, payroll reports, sales/meals/use tax, etc.
Not Testing a Business Model Before Opening
If you’re serious about starting up your own business, it is vital to establish a business model. Starting a new business on an “I’ll figure it out as I go” mentality can quickly lead to a failed business.
By definition, a business model is “a design for the successful operation of a business, identifying revenue sources, customer base, products, and details of financing”. Establishing these key factors in your business model and testing your products’ release to gather the functionality of your business can put you in the right direction for success.
For example, if you start an online business, you want to ensure that all software will be capable of maintaining online projected traffic as well as ensuring that check-out procedures are in place and accurately representing sales, including taxes, shipping, and shipping confirmation.
Not Incorporating as Business Grows
Once your business begins to grow, your next step, which should be highly considered, is to incorporate your business. Incorporating a business means to separate the businesses’ assets and income from the owners, shareholders, and investors, depending on the type of business trying to be incorporated. There are various options to choose from when incorporating your business, such as but not limited to, a Nonprofit, Limited Liability Company (LLC), Corporation-C Corp, and a Corporation-S Corp. Selecting the best business structure for your business is dependent on the type of ownership, liability, and taxes that are best applicable to your business.
Discounts and Free Services for Family and Friends
Typically, when starting a new business, your family and friends are among the first customers you have. With that following comes family and friends discounts, and all though done for the love of those closes to us, it is not practical. At the beginning of your business, best practice is to charge everyone a full and fair price for the product you’re selling. However, if you can’t seem to steer clear from being lenient towards your family and friends, your business model should include a potential income sheet. With that, you’ll be able to find percentages where your business will be able to gain profit at a discounted price.
Structured Pay – Using Company Money as Personal Money
Using company money as personal money is a sure method to guarantee failure, that is because you will lose money from your business by using to line your own pockets, and not even realize what is happening until it is too late. The best way to avoid this is by first understanding that for your business to grow financially, you will have a good business plan that can project your annual income. Once the business cash flows have stabilized, you can produce your personal income via a payroll system.
Missing Out on Business Deductions
Tax business deductions can make or break a small business, so it is important to consult a tax professional when filing end-of-year taxes. The deductions applicable can ultimately save you from overpaying or underpaying taxes. Business deductions can provide more income for your business and potential employees if used correctly.
Not Providing Employee Benefits
If your business begins to grow to the point that you have to hire an employee, you want to provide them with benefits. Benefits range from employee discounts, salary, the potential for growth within the business, 401(k), and health insurance. This will also keep your turnover rate low, which will make you a competitive employer. More importantly, now that you do not work for anyone else, you are responsible for creating these benefits for yourself and your family.
Not Planning for Self-Employment Taxes
Many self-employed individuals, especially in their first year and self-employment, are unaware of the self-employment tax. The Internal Revenue Service (IRS) lists the self-employment tax rate at 15.3%, divided into two parts—12.4% for social security and 2.9% for Medicare. This means that come tax season, you are responsible for paying this percentage of your income back to the IRS. So, you must plan and work proactively to set aside this money throughout the year.
Not Budgeting/Managing Cash Flows
Neglecting to keep a handle on the business’ budget and cash flow is a sure guarantee that the business will not flourish. A vast majority of small businesses fail due to a lack of cash management. Projecting out your business cash flows (budgeting) in 90-day, 6-month, and 12-month intervals can help keep you on top of your finances and adequately plan for the unexpected.
Falling Behind on Permits and License Compliance
Keeping your permits and licenses up to date ensures that you remain open. Complying with federal, state, and local licensing such as corporate and building licenses, and making sure the building is up to code with laws and regulations, will help you keep your doors open and steer clear from any problems with the law.
Risk Management – Ask Yourself What Can Go Wrong
Plan for setbacks. Life happens, and operations don’t always run as smoothly as planned. In your business model, you should create a section that runs through several scenarios that have the potential to affect your business negatively. For example, if you own a brick-and-mortar store and have projected sales of $10,000/month and a pandemic arises and forces you to close your doors, you will not reach your projected goal. A way to minimize loss for the month would be to move your business to an online platform.
Lack of Documentation
From the moment you begin to draw out your business plan, even if it’s on a restaurant napkin, you want to keep every piece of documentation related to your business. You don’t want to lose valuable information such as your startup costs that can potentially hinder and elongate the process of expanding your business.
Overall, starting a small business can seem like a scary and risky journey that not many are willing to take. However, if you set yourself up for success and avoid making these common mistakes, the transition from unemployed to self-employed will come with ease.
