How Small Business Owners
Go Out of Business
Three Pitfalls to Avoid
For over 17 years, our firm has been working with entrepreneurs who start their own business. During the initial meeting with the entrepreneur and discussing his/her plans, or meeting with a struggling business owner, we can often predict with reasonable certainty as to which businesses will succeed and which will fail due to the years of experience of working with such persons.
Our determination of ownership success is often centered on the following three items:
Cash is king, and knowing a business’s cash flows is a MUST if a business is going to be successful. New business owners need to incorporate a cash flow analysis in their business plan. We suggest that a five-year cash flow projection be done. While many entrepreneurs will do an annual cash flow, we recommend (at a minimum) that a monthly cash flow be done for the first two years as those are critical years.
A good cash flow needs to be prepared on a conservative basis. That means you need to implement worst case scenarios into your cash flow projections. In other words, when looking at the range of income and expenses the business may experience, use the lower projected revenues and the higher expense range. New businesses will experience unexpected expenses, so having a conservative cash flow projection will hopefully enable you to weather those unexpected expenses.
Keep in mind that when opening a new business, it can take weeks or months before you can open your doors due to finding a suitable location, contract delays, landlord negotiations, zoning laws, inspections, etc. Once you are open for business, customers need to find you. That can create a revenue delay of several weeks or months. And during these delays before your full monthly revenues are generated, you need to meet payroll, rent, loan payments, etc. In other words, positive cash flows usually take much longer than originally participated. Hope for the best, but plan for the worst.
A good business plan has a reserve of capital that can be drawn upon for those unexpected cash delays. This could be bank CDs, retirement funds, or family and friends who could lend money. If these capital reserves are non-existent, the business will be placed in a troublesome position.
When the entrepreneur’s business plan shows that a salary or a distribution is being paid to the business owner during the initial months of operations, it is a signal that the entrepreneur does not appreciate the cash flow challenges his (or her) new business will experience. The entrepreneur needs to have capital reserves to pay his personal living expenses while the business is starting.
Even established business owners need to periodically monitor their cash flows. Depending upon the type of business, inventory turnover ratio, receivables turnover ratio, sales revenues, etc., this periodic review could be daily, weekly, or monthly. [Read more…] about How Small Business Owners Go Out of Business