Why Small Businesses Fail: What Your Accountant Is Not Telling You
You’ve heard the statistics: Half of small businesses fail within their first five years and only a third survive 10 years or longer. Research has found poor cash-flow management is to blame for as many as 82 percent of startup and small business failures.
What about home-based businesses? Since more than two-thirds of entrepreneurs start their businesses from home, it’s reasonable to assume for every home startup that is successful there are several that don’t make it.
Not getting enough sales leads, lack of marketing, not enough support and fear – particularly fear of selling – have all been cited as reasons home businesses fail. Since home businesses can encompass everything from work-at-home sales jobs to tech startups, they also face a challenge that stymies growing businesses of all kinds: cash flow.
If you don’t manage your resources, you will outstrip your cash faster than you can earn it and put yourself out of business. Even companies that are doing really well can get themselves into trouble and never know it until it’s too late. These failures are not confined to those businesses that tank before they ever get off the ground. A significant percentage of businesses fail as the result of a spike in success they simply can’t keep up with.
The most dangerous time in a company’s life cycle is not when revenue is stagnated, flattened out or has started to decline. It’s when revenue starts to ramp up dramatically – often when the business owner has failed to plan for sustainable cash flow.
Are you scratching your head wondering, “Wait a minute – how is too much business a bad thing?” Growing businesses are most likely to fail when they:
- can’t scale fast enough
- invest too much in scaling due to improper forecasting
A cash flow crunch is among the top existential threats growing businesses face. Here are six warning signs your company may be headed for trouble, along with information on particular dangers, and some steps you can take to avert them:
1. Cash discounts are being missed. Cash discounts are incentives offered to buyers to encourage early payment that reduce the amount owed to the seller by either a fixed amount or a percentage of the total bill. Missing cash discounts is a danger sign because returns on cash discounts far exceed most returns on any other use of cash.
2. Vendors are being stretched beyond normal payment terms. If this situation is allowed to persist for too long it will irreparably damage these relationships and could impede the business from acquiring what it needs to operate.
3. Late fees are being incurred on lease payments or trade accounts. As with missing cash discounts, the effect of these penalties can far exceed the normal costs of traditional financing arrangements.
4. The age of accounts receivables is increasing and/or it is getting more difficult to collect accounts. If this one applies to your home business, you must uncover any issues that impair your ability to collect all amounts billed, and develop a plan to work through each issue. Your plan should include:
- Bill promptly and as often as possible.
- Collect all payments when due.
- Eliminate all barriers to payment.
- Provide all documentation necessary to facilitate payment at the beginning of the process.
- Aggressively follow up on overdue invoices.
- DO NOT work only the old accounts. If you focus only on the older accounts, you ensure that you will always have older accounts. Work the more current accounts in order to collect them before they become “old.”
- Stay on top of the situation. Who would youpay first – a vendor who is sending invoices on a consistent schedule with full supporting documentation who is diligent in contacting you to determine the status of a timely payment; or one that sends invoices irregularly with little explanation and no follow up?
5. Your debt is increasing without a corresponding increase in collectable revenue. There are numerous reasons why business owners incur debt. Most are perfectly valid and productive. However, there are times when business owners will take on debt in the hope that it will buy enough time to repair a damaged business or to prop up an inability to gain revenue traction in a particular market. This is a dangerous and frequently desperate action. It’s essential you avoid this situation. Some steps you can take include increasing scrutiny of operating expenses and liquidating underperforming assets or outdated inventory.
6. Deposits of payroll or other taxes are being delayed beyond filing deadlines. Avoid this situation at all costs. You should exhaust all other options before pursuing this course. Once you start down this path it is a dangerous slippery slope, as penalties can be severe.
Most of these warning signs are symptoms and not causes of cash flow problems (No. 4 is the exception) and most are the result of improperly managed operational problems. The key to avoiding a cash flow crisis is to do proactive planning on a consistent basis. Here are some proactive steps you can take to better manage cash flow:
Cash Flow Management Steps
- Develop an understanding about when revenues can be collected and create a forecast of the future cash stream (preferably weekly).
- Determine the timing of all operational cash disbursements.
- Identify any other disbursements such as owner distributions, principal payments on debt and capital expenditures (equipment, etc.).
- Subtract the disbursements from the receipts to determine cash balances for each future period.
- Update the information as conditions change in the business or the market that will influence the outcomes to maintain a realistic view of the future.
Remember, no forecast is perfect and you can always come back to adjust any items that look to be incorrect. This will not be as painful as it sounds. Start with what information you have and refine the process over time. By taking these steps you can avoid at least one of the major reasons that small businesses fail.