5 Common Financial Mistakes that Kill Small Businesses in Africa.

I’m sure you would have heard the notorious statistic that nearly 80 percent of small businesses that start today may die within the first 18 months. This is both a sad reality and a mind-blowing suicide rate by any measure. I call it ‘suicide’ because most small businesses actually kill themselves without knowing it. Entrepreneurs and small business owners often form bad habits and make harmful decisions that ensure their businesses don’t survive. Don’t get me wrong; a business can fail for several different reasons. Some of these reasons are external (like a bad economy) while many of them are internal (you and the way you run the business). Sadly, poor financial management is one of the biggest internal reasons for business failure. This article looks at five common finanical mistakes that small businesses make in Africa. If you already run a business, no matter how small, you may already be guilty of a few.  Let’s find out what these mistakes are…

Yes, it’s Always About The Money!

Every business (small and big) exists to make money. Period! Unless you run a charity, social program or some other form of not-for-profit organization, very few people would continue in a business that doesn’t make any money. If the goal of business is to make money, it only makes sense that entrepreneurs and small business owners would know how to manage their finances quite well, right? Unfortunately not!

Many entrepreneurs do not understand that a business is a living thing. And money is like blood to every business. If it doesn’t flow well, there will be trouble. If you let it waste or leak, the business will fall ill, weaken and probably die. Financial illiteracy is probably one of the biggest self-made reasons why thousands of businesses fail in Africa every year.

It’s not enough to have amazing business ideas. You need to understand money too! It doesn’t matter how wonderful your product or customer service; if your business runs into financial trouble, you’ll be unable to pay the shop/office rent, pay salaries or enjoy any profits. This article will be the first of several financial literacy lessons I’ll share with you to open your eyes to the dangers of poor financial management in your business.  

Let’s now take a look at five serious and common mistakes most entrepreneurs are likely to make when they start and run their dream small business…

#1 - Not Keeping Financial Records

Financial records are like temperature readings of your business. They provide important and invaluable information that acts as an advance warning system to alert you before something goes wrong. Most times, businesses don’t fail without showing signs and symptoms. How else would you know that your costs are high and rising out of control if you don’t keep records of monies you’ve spent? How can you know that your goods are being stolen by your employees if you don’t regularly take stock?

Accountability is a basic ingredient of success in any business (big or small). How can you be accountable when there are no records to prove it? How can any business succeed if it lacks the discipline to keep records? How can you know if you’re making profits (or losses) if you don’t write down or record your incomes and expenses? There’s just so much you can store in your head. Sometimes (and many times), your head may forget some transactions you made. But a little notebook, a file on your computer or a business management app will never forget. (photo credit: brightblue-solutions.com)

Keeping accurate and up-to-date records of financial activities in your business is not just for your own sake. Should you require capital investment from banks and investors, you would need to first prove that your business is profitable and can pay back the interest and returns. And how exactly do you prove that your business is profitable if you don’t have any records to support your claim? Nobody wants to invest in a business that cannot account for the money it spends or makes. Trust has to be based on something and keeping good records of your business transactions is solid enough for trust to exist.

Don’t be scared; you don’t need to be an accountant (and you don’t need to hire one) to keep good records. Keep it simple simple and basic. You can start out by recording the date, amount and some details about the transactions and you’ll be fine. Fortunately, small businesses usually don’t have the kind of complex transactions that exist in large companies. If you can pinch your pennies right, your small business could one day grow into a big company that hires a team of accountants and financial managers to handle its finances.

#2 - Confusing Revenue With Profits

It’s very important that entrepreneurs understand the difference between these two terms. Revenue (also known as Sales or Turnover) is the money that flows into your business from selling your products or services to customers. Profit is the difference between money that flows into your business (revenue) and money that flows out of your business (costs).

I was once involved in an oil trading businessthat had revenues of nearly $60,000 per month. A lot of money right? Successful business, right? Well, I wish you were right. Although we had all this money coming in, we were not making any money (profits) at all. The business was actually bleeding and losing money. Even though we had a growing number of loyal customers who enjoyed our service, we had to make the difficult decision to close down.

Many small businesses suffer the same fate. Their shops are always overflowing with customers; there’s a lot of money coming in but the business isn’t profitable. High costs are usually one of the biggest reasons for a business with a high amount of sales/revenue but low or non-existent profits. It doesn’t matter how much money (sales or revenue) your business makes, if your costs are too high, you’re at risk of running a loss. If you hire more employees than necessary (which means high salary costs) or take out a bank loan with a high and unfavourable interest rate, your business would likely bleed to death. The unfortunate thing is, it may look healthy on the outside, but it's very sick inside. It will only be a matter of time before the business crumbles.

Why did the oil business that seemed to make a lot of money still fail? Two reasons. First, in the retail segment of the market, the profit margin between the cost and sale price of oil is quite small. So, although we sold large volumes to earn high revenue, the profit was little. Second, we took out a bank loan at a time when interest rates were just too high. Whatever little profits that remained were wiped off by the high interest payments we had to make to the bank. At the end of most months, we were making losses. Although the business was fun and our customers loved us, we had to quit.

Morale of this story: Don’t confuse revenue with profits. No profits, no business!

#3 - Spending Money On Things You Don’t Need

Let’s say you have a brilliant idea and you’re excited about finally starting your own business. You spend some of your capital on designing a beautiful logo for your product brand. You pay a consultant to design an amazing website so everyone would know you’re a person of style and class. You hire a Personal Assistant and Secretary and rent a large office space in a nice part of town (even though you realise that the space is too large for your requirements). You’re spending all this money because you plan to start your business with a bang. (photo credit: learnvest.com)

Action time! You launch your business. You have already spent half of your capital on all the ‘flashy’ stuff. But you’re not worried. Business will be good. People would see your logo, lovely website and beautiful office space and rush in to become your customers. One month passes; another nine months follow and business hasn’t turned out to be as rosy as you thought it would be. The problem is, you’re running low on working capital. In another few months, the rent would be due for renewal and you may not have the money to pay for it and still pay staff salaries. If only you hadn’t paid for such a big office or hired too many employees, you would have had the money to survive a little longer.

Unfortunately, this scenario is a common reality that affects many small businesses in Africa. We are often tempted to be perfect and get it right from the very start. The truth is, entrepreneurs really don’t need a lot of stuff we spend money on at the beginning of our businesses. We often waste the precious capital we need to keep the business alive. By the time we realize our mistake, it’s usually too late to make any amends.

Don’t get me wrong. If you have an eCommerce business that primarily sells products over the internet, of course it makes sense to invest in an attractive website. If you plan to start a pig farm, of course you should spend good money to buy good breeding varieties. The point here is simple: don’t waste your precious capital on things that are not VERY IMPORTANT to your business in the beginning. Spend as if your new business would need to last up to three years before it makes any good profits.

The lesson here is to start and run your business as a lean model. A lot of uneccessary fat can negatively affect the health of your small business. Avoid fat. If you already have some in your business, make the hard decision and cut them off now. If not, they'll cut you out of business soon!

#4 - Short Term Expectations

Entrepreneurs are usually excited to finally transform their ideas into amazing businesses. This excitement and optimism is often so high that we expect our new business to be making a lot of money in a short time. Why shouldn’t we think so? Our ideas are often innovative and revolutionary. The demand is out there and customers are expected to come in their thousands. Some times, these plans work and an overnight millionaire is made. Other times, the story is different; things may not turn out the way we have planned. 

Some businesses start to turn a profit in their first week of operation. Many others don’t make any money at all until a year or two afterwards. Sometimes in life, things don’t always turn out the way we plan for them to be. And because the future is uncertain, it only makes sense that we prepare ourselves for the surprises that will most likely come up.

I’m not a pessimist at all but I find that it often helps to assume the worst case scenario when you’re starting a business. It’s unfortunate that our get-rich-quick mentality does not allow us to take a long term view of our business. When you take a long term view, it is less likely that you will become frustrated when you don’t see any profits in the first six months. With a long term perspective, you are likely to spend wiser and not waste money on those things that do not really matter in your business. A long term perspective also allows you to prepare sufficient capital for your long trip.

#5 - Not Paying Yourself A Salary

Starting and running your own business is such a powerful feeling. It means you’re the boss; the biggest gorilla in your forest! You don’t take instructions or orders from anyone and you can do as you please. Unfortunately, this feeling makes many entrepreneurs treat their businesses like an ATM; an automatic cash machine that produces money for their private use and entertainment.

Many entrepreneurs make the fatal mistake of confusing their business account as a private account. They’re totally different. Your business should not DIRECTLY be paying for your personal phone bills or children’s school fees. It is wise to pay yourself a salary as the owner of the business and discipline yourself to spend that salary within your means. If you continue taking money out of your business to spend on private stuff and things that do not contribute to the growth of your business, you’re asking for trouble.

Get it straight; you may be the boss almighty of your small business but your business is separate from your personal life. If you want your business to survive and grow bigger, you will have to respect its financial independence. If you want to be able to take money out of the till, work harder. The harder you work to grow your business, the more money your business makes and, as a direct consequence, the salary you earn can be higher.

A salary forces you to be disciplined. At the first signs of success, some entrepreneurs take money out of their promising businesses to fund a lavish lifestyle; a new home, a fancy car and vacation trips abroad. All of a sudden, the business (which was doing very well) starts to weaken and may probably die. If there was a salary mentality in place, there may have been a little more discipline and wise planning in spending the money.

Just to be clear, your salary as the business owner may or may not be fixed. A good method is to pay yourself a portion of the profits you make in a month (commission basis). I prefer the commission basis because it motivates you more than a fixed salary. If the business makes more profits, you earn a high salary and vice-versa. This mentality is likely to keep you more focused on growing your business rather than wait until the end of the month to pay yourself a fixed salary (whether the business performs well or not).