According to the SBA, a company’s chances of survival is about 50 percent in the first five years. Babson University’s 2013 Global Entrepreneurship Monitor report says the top two reasons for going out of business are problems getting financing and business isn’t profitable. These two affected more than half of the businesses.
CB insights collected input from more than 100 failed startups. Almost one-third cited running out of cash as the reason for failure, the No. 2 reason. The first was the lack of market need.
The truth is that running out of money isn’t the company’s fault. It’s the side effect of another issue. Small business owners or managers could be making poor spending decisions, failing to get capital for business, or struggling with cash management.
If cash flow management isn’t under control, any one of these five things can sink your business.
Some small business owners keep track of their accounting using an Excel spreadsheet. Unless they’re spreadsheet masters, it’s highly unlikely they have a spreadsheet that can create profit and loss statements, balance sheets, and cash flow statements. You can’t run a simple report to display your aging accounts receivables in Excel.
Effective bookkeeping means creating an invoice from accounts receivable, tracking payments, staying on top of bills, and producing reports. Using proper accounting software can do everything in a few clicks. They are built for this. A good one can quickly pull up overdue invoices so no invoice goes unpaid for too long.
It’s important to understand cash flow 101 and produce the accounting reports that best tell the story of your business. If you rely on just the profit and loss statement, you won’t know how much cash you have in the bank. If you rely on just the cash flow statement template, you won’t know if you’re making a profit. Money in the bank doesn’t indicate profit.
If needed, contract an accountant to set up your software for you. Have the accountant show you what to do and when. Learn how to create profit and loss statements, balance sheets, cash flow statements, and cash flow forecast. You can search for a cash flow template and cash flow statement example on the Internet.
Gap in timing for invoices and expenses
Let’s use a simple example. Say a company has a $100 credit card payment due on the 15th of the month. And it invoices its only client for $500 on the first of the month to be paid within 30 days. That’s enough to pay off the credit card. If the client pays you after the 15th, it becomes a timing problem. Since there’s no other income to pay the credit card, the credit card company will charge late payment fees and interest.
That’s a simplified example. In reality, you manage payroll, various expenses with different due dates, and many invoices in the accounts receivable process. You can modify due dates to ensure you have the money to pay what you owe. Some vendors and credit card companies will work with you on that.
The key is to stay on top of your accounts receivable by creating processes, documenting everything, and communicating with clients and employees. Promptly invoice clients to cut the time between finishing the work and getting paid. One way to speed up payment is to offer a discount for paying by a set date. If you have many unpaid invoices, you might opt for factoring.
Lacking cash reserves
Emergencies happen. What do you do when your refrigerator breaks and can’t be repaired? You most likely buy a new one with the money you set aside for things like this. One small business owner discovered a serious accounting error. He learned they had $35k less in the bank than originally thought. For this small business, it was a big chunk of money. The owner had to let people go and make cuts. True story.
It’s not just emergencies that can throw a business for a loop. Maybe you need to make a change to your services or product because it’s not selling well. Adjustments cost money.
How much cash reserves should you have? The rule of thumb is to set aside six months’ worth of operating expenses. Since it takes time to build reserves, you can speed it up by being conservative when estimating the amount of income you expect from sales and keeping the cost of staying in business as low as possible.
Growing too fast
You land the biggest contract of your business life. But you don’t have the resources to support it. This undertaking calls for hiring two more employees. However, you will probably need to pay those employees their first paycheck before you see your first payment from the new client. It’s a catch-22.
How are you supposed to grow if you can’t take on bigger projects? This is where a small business loan can help. Factoring, or invoice discounting, also works if you have enough cash in your unpaid invoices. It gets you the money you’re owed faster. Both options supply you with the needed working capital to cover your increased expenses.
Struggling to make profit
No amount of cash reserves can save a small business if management doesn’t determine what’s draining the profit. Or maybe the business needs to increases its prices. A cash flow statement — especially when compared to actual figures — can pinpoint trouble spots to help you make better decisions.
For example, you discover your web hosting bill is higher than your forecast. What can you do to close the gap? One option is to shop around with other web host providers. When you find one that fits your needs and for less, take that quote to your current provider to see if they’ll lower your bill.
New and not so new small businesses can run into these cash flow management problems. At its most basic, you want to make sure you have more money coming in than going out. Watch for these issues to ensure your business has positive cash flow. Once a business runs out of money, it’s dead in the water. Don’t let this be yours.
Image credit: Jon Wisbey