The Financial Reasons Small Businesses Fail

Almost every entrepreneur has heard the statistic:  80% of small businesses fail.  There are many reasons this happens, and can include everything from market slumps to lazy owners.  To enumerate every way a business can go under would be an endless, impossible task.

However, there are a few financial characteristics frequently found in struggling businesses.  Here are the most common financial reasons small businesses fail.

There’s no plan.  It’s not uncommon to meet new small business owners who have a brilliant product idea, a well-developed marketing plan, a slick website, and not one thought given to their budget.  We’ve already written on the tough financial questions to answer before starting your own business, but the importance of a solid financial bedrock cannot be overemphasized.  A well-researched budget and fixed goals is the key to surviving that crucial first year in which most businesses go under.  Great customer service and spot-on marketing are not enough to balance out shaky financials.

Speaking of customer service…

Poor credit management and pricing strategies are bad for everyone.  No one craves popularity like an entrepreneur and, when your business’s success is entwined with how well-liked you are, the urge to avoid offending anyone becomes even stronger.  In the early days of a business, when there are only a few customers, there is a common impulse to let clients slide on late payments, or to offer frequent “friends and family” discounts.  It’s easy to justify this with the logic with the idea that you need to establish customer loyalty, and you can tighten the reins a bit when you have a solid customer base.  There are a few reasons this doesn’t work:

  1. Clients who don’t pay on time aren’t going to appreciate the slack you’ve given them in the past; they are going to resent the restrictions you enforce in the future.
  2. Likewise, your patrons who are just coming to you for the lowest price will quickly go elsewhere when your rates rise.

Lenient accounts receivable and cheap pricing might gain you a quick boost in early sales, but they are not a sustainable model.  Delivering a product you can be proud of, at a price that is worth your hard work and can keep your business afloat (and actually requiring customers pay you that fair price) ensures that your customers the pleasure of patronizing your business for years to come.  Because you have to remember…

Cash is king.  Yes, it’s a cliche, but that doesn’t make it any less true.  A great business model matters little if you run out of money before you can implement it.  Managing cash flow is key to not just the health but the continued existence of your business.  Here are a few of the most common cash pitfalls small businesses face:

1.)  Insufficient capital.  In all likelihood, your business will not be immediately profitable.  So not only do you need enough cash to get your business started, but you need enough to allow yourself to operate at a loss for a while.

2.)  Not having a large enough cash cushion.  Think “Princess & the Pea” levels of padding.  Regardless of how well you plan, the economy is unpredictable.  Look to history for examples.  No one expected the Boston Molasses flood which, in addition to the damage caused and lives lost, resulted in a nearly $11M settlement (in today’s money) for the responsible company.

3.)  Over-investing in fixed assets.  It’s great to plan for the long-term but, if you don’t plan for the short-term as well, your business will not get a long-term.  Sacrificing too much of your cash for something like manufacturing equipment (even if you’re getting a great deal) can hurt you, as that is not a liquid asset and will be of no help to you in the event of an emergency (i.e. your factory flooding a major metropolis with 2.3M gallons of molasses).  Think of it like a game of Monopoly; if you start building hotels too soon and suddenly need cash, you’re stuck selling all your buildings back to the bank for half-price, and you know bankruptcy is right around the corner.  Only, in real business, instead of losing yet another game to your annoying brother-in-law, you’ve lost your entire livelihood.

Expanding your business is the ultimate goal, but maintaining cash flow gives you the solid foundation you need to build upon.

80% of new businesses fail, but that means 20% succeed.  To be that 1 out of 5, have a plan, know your value, and remain patient.  Better to start small and grow something big than to start too big and dwindle away.

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