When entrepreneurs prepare financial forecasts for their business plans, they sometimes overlook costs that might have the potential to derail their business. That’s particularly problematic if a bank relies on a forecast during the initial underwriting process or on an ongoing basis to justify increases in a start-up borrower’s debt. Here are four costs entrepreneurs tend to leave out or miscalculate.
In today’s litigious environment, businesses must protect themselves from a broad range of risks. Insurance can help small business owners mitigate the risk of running a business, but it’s important for them to get the right type and amount of coverage. Most insurance companies offer a general liability policy for small businesses that serves as a good starting point. It includes a suite of insurance products that are most relevant to small businesses. However, borrowers also should consider purchasing add-ons, such as flood, terrorism or cyberinsurance addendums, depending on their location and the nature of their operations.
2. Fraud, obsolescence and spoilage
Business owners don’t expect to be victimized by fraud. While theft happens infrequently, dishonest employees, customers and suppliers do steal. In fact, small businesses tend to suffer higher fraud losses than large ones. The median loss for businesses with fewer than 100 employees is $200,000, compared to $104,000 for larger organizations, according to the 2018 Report to the Nations by the Association of Certified Fraud Examiners.
Inventory can be especially vulnerable to fraud and theft. Although shrinkage estimates vary, businesses generally report losing between 1% to 2% of inventory to theft. In addition, over time inventory may become obsolete or damaged — especially in small businesses that sell technology-related products. When writing off obsolete products, borrowers should offset estimates with revenue earned from disposing of those items at a deep discount.
3. Personal salary misstatements
Some entrepreneurs exclude their salary from the start-up’s expenses. If a borrower is determined to forgo his or her salary, ask how much savings the entrepreneur has set aside to pay their basic living expenses. Your discussion may lead to revised forecasts that include the amount they need to live on while building the business.
4. Professional fees
Most start-ups need legal and accounting advice. At a minimum, forecasts should include any legal fees they expect to incur at formation, as well as legal and accounting fees due around tax time.
A business plan’s accuracy depends, in part, on the small business owner’s ability to identify and quantify relevant costs. When a small business owner omits or underestimates certain costs from their forecasts, the potential for financial strife in the future grows.
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