The Common Pitfalls of Running a Business

Small business start-ups including the self-employed are projected to keep growing in the US.  Every day, thousands take the plunge and start their own craft.  But running a business on a hazardous landscape is tricky and little do they know how easy it would be to fall into a trap that many have fallen into.

Before an entrepreneur can even think about expansion or growth to get it further off the ground, the business must be built on a rock solid foundation – first and foremost.  Let’s look at some of the pitfalls entrepreneurs and small businesses with limited resources or knowledge find themselves exposed to.  Avoid these mistakes as if your life depended on it – your financial life that is:

  • Commingling or Intermingling Funds
    One of the most dangerous financial mistakes a business owner can make is to intermingle funds, such as paying personal expenses from the business checking account, or paying business expenses from the owner’s personal account. This can be done with the best of intentions with the business owner making adjustments in the books to separate the business and personal transactions, but the behavior can leave openings for the IRS or courts to question the integrity of the business entity or the transactions. Failure to maintain complete financial separation between a business and its owners is one of the major causes of tax and legal trouble for small businesses.  Good record-keeping is key.
  • Employee or Independent Contractor? 
    In order for a business owner to know how to treat payments made to workers for services, he or she must first know the business relationship that exists between the business and the person performing the services. A worker’s status determines what taxes are paid and who is responsible for reporting and paying those taxes.  A worker performing services for a business is generally an employee or an independent contractor. If a worker is classified incorrectly, the IRS may assess penalties on the employer for nonpayment of certain taxes. The factors to determine worker status can be grouped into three categories:
      1) Behavioral control – factors that indicate a business has the right to control a worker’s behavior such as instructions and training that the business gives to the worker.  Independent contractors are independent of business control or employer-imposed schedule.
      2) Financial control – factors that indicate whether a business has the right to control the business aspects of a worker’s job including unreimbursed business expenses, extent of the worker’s investment, and the extent to which the worker makes his or her services available to the public. Independent contractors are generally free to offer their services to others.  Method of payment for services performed is also considered as independent contractors are generally paid a flat fee for a specific job.  Exceptions apply to some professions such as accountants and lawyers who charge hourly fees for their services.  And the extent to which the worker can make a profit is a definite factor as independent contractors work to make a profit.
      3) Type of relationship between the parties – factors that indicate the type of relationship status include written contracts that describe the relationship and intent between the two parties; employee-type benefits provided to worker; permanency of the relationship as to the extent of services performed by the worker.  An independent contractor usually has a beginning and an end date for each assignment.
  • Negative Cash Flow aka Cash Burn                                                                                                                                                                                                            For any businesses, big or small, cash flow more than profit is the best indicator of its long term survival.  It determines whether a business will be able to pay its expenses and debts as they come due. A business plan should contain a statement of projected cash flow (basically a money trail of where the money is coming from and going to) for the first 12 months of the business.  Lenders or investors may require customized reports indicating cash flow and profit projections.  More often than not, many operate with a negative cash flow due to mismanagement of resources.  And many over-extend with credit because sales are poor or the ability to collect accounts receivable is lacking.  For the Sch C filers and small businesses, the inability to pay self-employment tax on net income or income tax in general can also be a stressful trap especially when the IRS or the State comes knocking at your mailbox.  Cash is King in running a business.
  • Hiring Friends and Family because of Likes or Obligation                                                                                                                                                              Finding and hiring the right people can pose a real challenge to brand new businesses.  Too often, many turn to the pool of people they already know or trust feeling more secure with them.  Or maybe a loved one is down and out and they feel obligated to help out.  But hiring family and friends can be a volatile idea.  A well-run business relies on a clear understanding of boundaries and defined roles of responsibility.  When personal relationship is intermingled with business, it’s easy for the lines to become blurred between employer/boss and employee.  In addition, the pressure of running a business is stressful enough that can test the limits of any relationship.  So it’s best to avoid hiring friends and family for a drama-free work environment.  Hire the best absolute candidate for what the business requires, and just like with money, don’t commingle business with personal.
  • Not Hiring a Good Lawyer and Not Hiring an even Better Accountant                                                                                                                                                  As a new business owner, issues such as legal counsel or business insurance can seem unimportant or considered unnecessary luxuries.  The truth is, an ounce of prevention is worth a pound of cure.  Having a lawyer well versed in the industry you serve is invaluable – not just in time of crisis, but also as a business adviser and protector.  Similarly, many entrepreneurs run their business by do-it-yourself (DIY) bookkeeping and/or tax filings to save money while most lack the basic knowledge of proper record-keeping.  This is another area where it’s unwise to cut corners.  A CalCPA study finds that 80% of small business owners report that they aren’t claiming all the deductions they are entitled to, highlighting a need for trusted counsel.  It also states that 31% of accountants surveyed believe the biggest mistake made by small businesses is not setting up regular check-ins with their accountants.  A good accountant is worth his or her weight in gold.  It definitely does not pay to skimp on the important aspects of running a business.  Not hiring the right help can cost entrepreneurs a lot of money, or worse their entire business due to possible litigations.

For an illustration on how a business owner with good intentions can go wrong, click on the link to read my CPA friend’s article on “A Recipe for Failure” that many entrepreneurs have to dig themselves out of all too many times.

The key to running a business successfully is knowing about and avoiding the many pitfalls that could entrap you into failure.  Learn to structure your business accordingly and you’ll not just run a great business but will get it off flying high into the stratosphere on a rock solid foundation as well.

I’m a CPA who assists individuals, entrepreneurs, and small businesses navigate the complex world of tax compliance along with other business issues through planning strategies or ideas.  It’s essential that entrepreneurs stay focused on their own key craft and achieve a more balanced approach to any pursuits.

Besides helping clients, I’m a blogger who enjoys writing useful and relevant contents (see my other blogs).  You can also Connect with me here to schedule a free 30 minute consultation about your tax situation.  #JustStayFocused #SanDiegoCPA #JustGetBalanced!

With proper help, it doesn’t have to take an “Einstein” to run a business.
Running a business doesn’t have to feel this way.

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