Providing comprehensive financial advice to small business owners can be as emotional as it is practical—after all, their business is their most valuable asset. It’s where they spend most of their time, both physically and mentally. It’s likely a dream they’ve built from the ground up.
One of the most valuable things you can do as a financial advisor is help the owner protect that dream. Give them the guidance they need to avoid making these five common mistakes.
1. Underestimating the impacts of fixed and variable costs on profit margin:
First, let’s define the two costs of operating a small business.
- Fixed costs must be paid no matter the volume of products or services sold—for example, rent and other property expenses, marketing and advertising fees, and salaries excluding tips and commission.
- Variable costs are directly related to the volume of products or services sold. When sales go up, so do variable costs, and vice versa. For example, raw product materials and production supplies, distribution costs, shipping charges and sales commissions.
To understand the impact each type of cost has on the business, business owners can calculate profit margin and break even volume.
Profit Margin = Retail price per unit - variable cost per unit
Break Even Volume = Fixed costs / Profit margin
While fixed costs are, well, fixed—that is, rigid and difficult to change—variable costs can often be reduced to increase profit margin. Business owners should consider whether it’s feasible to spend less on raw materials, buy in bulk, and lower distribution costs. They can also implement more effective employee training to increase efficiency.
2. Setting unrealistic sales projections
When business owners set sales goals that are too aggressive, they can create real financial problems for their business by investing in inventory or hiring additional staff to meet demand that isn’t there.
On the flip side, goals that are too conservative can leave the business unprepared for accelerated demand, creating poor customer and employee experiences.
The problem most business owners face with setting annual sales targets is that they follow a framework that’s too simplistic and internally focused—last year’s sales multiplied by an industry-specific growth rate.
This does not account for the very real external variables that also drive buying behaviors (i.e. the economy, supply chain, market trends, even the weather.)
Help your business owner clients set realistic goals by asking them critical questions:
- What percentage of your revenue is recurring?
- What’s your average customer acquisition cost?
- What are your variable costs, fixed costs and profit margins?
- How many new customers do you need per month to hit your goals?
3. Mismanaging cash flow
Cash flow problems top the list of reasons small businesses fail—in fact, research shows that 82% of small businesses fail because of cash flow issues.
Various factors affect cash flow, including industry and business stage, but one constant remains: A business’s expenses should not exceed its existing cash.
Keep your clients from succumbing to cash flow catastrophes. Help them understand that properly managing cash flow means:
- Balancing funding growth with smart, conservative spending
- Understanding exactly where cash is being spent
- Prioritizing bill payment to protect credit
- Closely tracking inventory
4. Maintaining an insufficient emergency fund
Look no further than the events of the last few years to see why small business owners need to prioritize an adequate emergency fund. Having cash reserves in place for slow seasons, unexpected economic downturns, lawsuits, employee illness—the list goes on—can be the difference between keeping a business afloat and closing the doors permanently.
Ideally, small business owners should have six months of business expenses saved. Help clients understand what that number is, and how to get there.
5. Not consistently reviewing budget
Typically, small business owners review their budgets annually—when they’re getting ready to prepare next year’s budget. But doing that can mean missing out on subtle increases in expenses, like higher supply costs, and opportunities to reduce variable costs in order to increase profit margin.
Most importantly, what can be measured can be improved. The closer a small business owner is to their numbers, the more swiftly they can adjust business processes to optimize for new opportunities or get ahead of potential problems.
Understanding budget is critical for small business owners. Suggest that your clients review their budgets at least bi-annually, if not once a quarter, and make adjustments as necessary.
Valuation: The Ultimate Foundation for Better Business Decisions
Valuation drives every critical financial decision a business owner makes, from purchasing adequate insurance coverage to creating buy/sell agreements to developing a succession plan.
And for financial advisors, consistently showing clients the value of their business is a powerful way to prove your value. If you run a business valuation for a small business owner once every six months, and the value of their business consistently increases based on your financial guidance, it’s nearly impossible to argue with the impact you’ve made.
BizEquity’s business valuation software not only helps business owners understand their four estimates of value—asset sale, equity, enterprise and liquidation—it also generates critical KPIs and industry-specific benchmarks, so they can see where they stand against their peers, where they’re performing well and where there’s room for improvement.
To learn more about BizEquity’s valuation software for advisors, click here.
