How to Identify Risks and Financial Problems

Small businesses are often at risk of becoming financially unhealthy. This is due in part to the competition, and the entrepreneur is not trained in financial matters. While a significant number of small businesses do end in bankruptcy, many will go on to be successful.

Often, a small “budding” business looks promising. Growth is good. There is a strong demand for the goods or services the small business is offering. However, the business doesn’t ever seem to grow beyond the initial upstart stage into a stage of maturity and stability. Many of the reasons a company doesn’t continue to mature are financial.

To help you avoid these financial traps in your business, let’s examine what those are.

1. Insufficient capital. The best place to look for capital is the balance sheet report. Examine the working capital of the company to determine if they have enough available capital. Working capital is determined by subtracting the current liabilities from the current assets. The term current means either the debt is due in one year or less, or the asset can be converted into cash in less than one year. Take a look at the debt:asset ratio too. This ratio will tell you how much of the assets are leveraged. The debt:equity ratio will show you the source of their capital. You will find these numbers on the balance sheet.
2. Inaccurate cost estimates. If you begin with poor models, your results will be poor. Poor models in estimating the costs of production and the cost of goods sold are among the most common issues new companies face. If you get these estimates wrong, then your profit estimates will be wrong. Invest time and energy in researching the costs of your business. Don’t wing it. Your numbers will become more accurate as you gain experience and track your expenses accurately.
3. Poor budgeting. Negative cash flows can quickly occur if no one is watching the checkbook. Budgeting is a two-step process. First, invest the time and energy to create a budget. Second, use the budget regularly. Refer to it monthly. Compare your actual number to your budgeted numbers. If there are differences, seek to understand why. The budget is a tool to help you plan for the future and attain the objectives and goals you’ve set.
4. Inability to maintain cash flow. Poor cash flow results from either too little cash flowing into the companies. In a small business, this is likely due to poor sales. The other factor of poor cash flow is poor management of expenses. To obtain a clear understanding of the flow fo cash through the company, examine their statement of cash flows.
5. Not seeking assistance when needed. Advisors such as CPAs are expensive, but shouldn’t be considered a cost, rather an investment. Some expenses can actually save you money. This is one of them. Seeking legal advice is also worth its weight in gold.
6. Unsustainable growth. Growing too fast and outgrowing your current capacity is a good way to outpace your processes, cash, and capital. Plan your growth and be prepared to say no to potential customers. This will do two things. First, help you control your growth rate and ensure your processes can handle the volume and demand. Second, it will create scarcity and allow you to raise prices, improving your margins hopefully.
7. Loss of sales/revenue. Track and trend your revenue sources. If revenue begins to decline, ask questions. Reach out to your customers or former customers and see why they are no longer doing business with you. Are the reasons specific to the customer or are more broadly based?
8. Paying for unnecessary services. Every dollar must be used appropriately. If the dollar leaves your checking account, it needs to provide a return on investment in some manner. If not, you’re wasting money.
9. Buying equipment instead of leasing. Buying equipment can see nice on paper as it can impact the net profit. However, the investment of the capital can impact your reserves and working capital. It is a question of the flow of cash vs. capital expenditures. There are other questions to consider, such as who is responsible for repairs and maintenance? Is there a warranty if you purchase? How much will it cost you to maintain the equipment? Sometimes leasing the equipment makes better financial sense. Seek assistance from experts to help you determine which route you should go.
10. Failure to track the numbers. I’ve worked with physicians who never looked at their financial reports. They could not tell me what they earned per patient or what it cost them to see a patient. Not tracking revenue and expense per customer is a very good way to get into financial trouble. Each month, I recommend you examine your costs and reports.
11. Poor debt management. Debt can either be good or bad. It depends upon the terms of the note and how you’re using the money. Are you borrowing for an investment or using the money to make payroll or other expenses? Poorly managing debt is a primary reason why small businesses get into trouble.
12. Unforeseen expenses and lack of reserves. Always have a reserve and a plan for the worst-case scenario. When I fly my airplane, the FAA mandates that I have enough fuel onboard to get to my airport and an additional 45 minutes to fly. Why? Because they want to make sure I can get down safely. I, too, want you to be safe. Build a reserve for those unforeseen expenses. The longer you operate your business, you have a better idea of how much you should have on hand.

Examine your business and see if any of the problem areas listed above are present. If they are, visit www.davidnorrismdmba.com and contact me today. I can help you get your business on the right track.