Written for EO by Michael Neidert, a writer and consultant.
Finance is a common source of both challenges and opportunities for a growing company. What you are spending your money on and when you spend are often key indicators for an organization’s financial success or failure.
When you’re thinking about sales, you may forget about setting a savings rate. When you’re thinking about saving money, you may miss out on places to continue spending. When you’re just trying to make it through the end of the month, you may lose focus on your long-term goals.
Learn these foundational finance lessons now to set yourself up for success:
Avoid the sunk cost fallacy
As a vulnerable new business founder, it’s easy to submit to sunk cost thinking. After all, you begin your business with the best of intentions and the greatest of hopes. It’s hard to face that you, first, have what are considered sunk costs—investments that you will never recover—and, second, are making decisions based largely on these lost assets.
The sunk cost fallacy takes over when you believe that further investment in time or money is justified because of the resources you’ve already invested will be lost otherwise. You fail to consider the overall losses you might suffer in making further investments. Simply put, you justify a previous choice by repeating the choice.
For example, you might’ve chosen the wrong project management tool but continue to use it because you feel guilty about “wasting” money. By continuing to use it, you certainly won’t recover the cost. If anything, you’re losing opportunities and efficiency and only adding to your losses. Or, arguably worse, you commit to “making due” after realizing you’ve made a bad hire.
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Whether it’s a piece of software, a CEO or a process you’ve implemented, don’t fall for sunk cost thinking. Focus on the long-term value and, if something isn’t working, don’t double down and commit to making it work based only on reinforcing your mistake.
While a big win can feel like the right time to celebrate and indulge, don’t forget that new businesses must withstand ups and downs. Sure, you might have closed a big sale, but it may not be the right time to treat the sales team to an all-expenses-paid weekend retreat.
Instead, remember that current performance, no matter how strong, doesn’t necessarily indicate future performance. Your best six months could be followed by your most difficult year, so spend and save accordingly.
When it comes to saving, many experts recommend having at least six months of your total costs in cash reserve, including rent, salaries, loan interest and other costs.
Your specific savings sweet spot will vary based on cash flow, costs and the ability to save. When in doubt, refer to a finance professional for guidance.
Did you know 29 percent of startups fold because they run out of cash. Is yours at risk? Find out by reading more financial tips for rookie entrepreneurs on EO’s Inc. blog channel.
Spend on growth
One common mistake that rookie entrepreneurs are likely to make is failing to invest in growth, especially in downturns. When business is slowing, they look to make cuts, reducing sales and marketing budgets, the very functions that could help reverse the slow-down. Consider that sales and marketing are the engines for bringing on customers and ensuring your bills get paid.
Of course, each case is unique and specific to the business and scenario. However, if you’re looking at where to cut or invest, look closely at how increases or decreases in spending will affect your revenue-generating activities.
Develop short and long-term vision
Although developing short and long-term vision is critical in every part of your business, including sales, product and hiring, it’s particularly helpful in finance topics.
If you only look short-term, you’ll likely be reactive. When this happens, you’re left scrambling to pay invoices or even maxing out credit cards.
If you only look long-term, you may find yourself guessing or assuming too much. It can be difficult to say exactly how technology, markets or regulation could impact your business in the next two to 10 years.
A healthy mix of both short and long-term vision will help you see the opportunities in front of you, anticipate changes that affect your day-to-day operations and still have a vision that guides the organization.