Small businesses fuel much of the United States economy, and the popularity of shows like Shark Tank has sparked interest for those who want to become entrepreneurs and their own boss. However, owning and growing a small business is definitely not a sure thing, and the statistics are telling. According to the Bureau of Labor Statistics, about 20 percent of small businesses fail in their first year, and about 50 percent of small businesses fail in their fifth year.
According to Investopedia, the four most common reasons why small businesses fail are a lack of sufficient capital; poor management; maxing out their marketing budgets and inadequate business planning.
Many small business owners may not realize the importance of financial planning for their business and forecasting for all sorts of circumstances, said James D. Di Virgilio, CIMA®, CFP® Certified Investment Management Analyst and Certified Financial Planner for Chacon Diaz & Di Virgilio Wealth Management Firm.
“For small businesses, obviously cash flow is critical and ideally you should begin with a five percent surplus in your budget,” Di Virgilio said. “But beyond that, my biggest piece of advice for small businesses is to plan budgets and response for three different types of scenarios—pie in the sky, conservative and disaster/crisis—so that you can plan for future situations that may occur in your business.
For example, it is recommended that owners work with a financial planner and plan out a budget and profit plan, but if a crisis occurs like an equipment failure, economic downturn or other adverse event, you have to have a plan to deal with those losses before you become emotional and caught in a crisis. You have to make difficult decisions about what you may need to cut, even if that means lowering costs by cutting staff. It is very hard to cut employees who you may have a relationship with, but you have to realize that the company comes first.
Being a business owner does not exempt people from also continuing their own personal financial planning. Di Virgilio recommends keeping these two as separate as possible so that a business owner always has a safety net and continues to save for their own personal retirement and other family financial goals, such as college funding, long term care and other needs.
“Your personal and family financial planning have to be separate, which can prove to be very difficult, if not impossible, to do for many people,” Di Virgilio said. “Most business owners, especially very small businesses, should not anticipate receiving any sort of financing or funding from others. The basic lesson is you have to work with whatever financial resources you have in hand that you have saved for your business. Do not expect a bank loan, credit cards, or a second mortgage to fund your business.”
Financial planning for small business has to take several factors into account like tax laws, managing risk with different types of business insurance, and balancing investments into their business. In addition, hopefully, if a small business grows and is successful, it becomes its own entity and estate planning may become necessary, which may include setting up a family trust and personal will. These types of factors can also affect financial, tax, medical and business planning.
Although most small business owners and entrepreneurs are risk-takers, that do-it-yourself attitude is not recommended when it comes to business planning. Professional expertise is often necessary when developing a financial plan.
“I believe it’s obvious that business owners should seek professional advice during financial planning,” Di Virgilio said. “Tax and financial experts can advise you during planning because they understand the laws, taxes, and necessary items to be a part of any financial plan. I would also recommend using a certified financial planner and either a certified financial advisor or certified investment management analyst.”
Di Virgilio also recommends ensuring the financial advisor is a fiduciary. Many Americans believe that all financial advisors are fiduciaries, which is inaccurate. A fiduciary is a person or legal entity, such as a bank or brokerage firm, that has the power and responsibility of acting for another in situations requiring total trust, good faith and honesty. According to the Securities and Exchange
Commission, this entails always acting in your beneficiary’s best interest even if it is contrary to the fiduciary’s benefit.
Although there is inherent risk involved with owning your own business, current statistics also show that many small businesses are alive and thriving, and the number of female-owned and minority small business owners continues to rise. For those who are looking to open their own business, careful planning and professional assistance can be a key factor to success.
By Tracy Wright