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Why Does Small Business Fail and How to Prevent It?

It is a sad and hard topic to write about, but it is extremely important to discuss why small businesses fail and what can be done to prevent it.  Small businesses fail for a myriad of reasons, most of which can be traced back to inadequate working capital, resulting in the inability to meet their obligations.

Failure to Forecast Changes in the Business: 

I know it is difficult for the reader to take me seriously when I say you need to predict the future, but it is easier than you think.  Businesses need to go through the planning and budget process, they need to take critical evaluations of their sales pipelines and talk with customers about expected volumes in the future.  As a business owner, you need to know where your business is headed, in order to properly lead a successful operation.  It is necessary to understand whether you are catering to happy customers or unsatisfied ones who are looking for a new product or service supplier.

Over-Dependence on a Single Customer: 

The importance of diversifying your revenue streams cannot be overstated.  It can be very easy to service one customer, but then your business is totally dependent on the whims of the other company.

Poor Management: 

When you are your own boss, in addition to your managerial duties, you are responsible for your company’s culture and working environment.  Professional development opportunities for your employees is a major component necessary to maintain a stable work force which can uphold a high level of service.  If you do not create a successful business culture, your employee retention, customer base, and revenue will be negatively affected.

Incorrect Pricing Strategy: 

When pricing your product or service, you need to make sure your prices are set at the inflection point between value gained by the customer and profitability for your company.  Hitting this mark can be challenging, as you have to set prices at a level attractive to the market place and customers are happy to pay your prices, but this price point is also profitable for your business.

Inadequate Working Capital: 

Working capital is the money needed to run a company on a daily basis.  It is the difference between current assets and current liabilities.  Lack of working capital is the main reason companies fail.  All of the above causes for business failure eventually will lead to a lack of working capital.  In terms of running a business working capital is equal to the runway an airplane uses to take off or land.  The longer the runway the better the chance the pilot can take off or land the plane.  The longer the runway the better able the pilot is to manage challenging scenarios like headwinds, crosswinds, or storms. Without sufficient runway, the winds, storms, or challenges will create a crash because there is no room to maneuver.

What Can Be Done to Prevent Business Failure?

Have a Thorough Understanding of Your Market and the Long-Term Potential:  As a business owner, you need to review your market periodically, analyze your position in that market, and compare it to your previous analyses.  You should perform a SWOT Analysis, so you can gain a better understanding of your strengths, weaknesses, opportunities, and threats.  This analysis can yield out of the box results that can really help a business owner maximize profits.  SWOT is an acronym for Strengths, Weaknesses, Opportunities, and Threats and is a structured planning method that evaluates those four elements of an organization.

Plan, Budget, & Forecast: 

The budgeting and forecasting cycle is extremely important.  The forecast can help the business owner to understand where the company is going.  What if you are about to lose a large customer, but are being asked to hire 5 additional people?  By understanding where the company is headed, you can better plan for the future.  Instead of hiring permanent staff, perhaps consider contract labor to cover the capacity shortfall, before the pending lost customer is gone.  That would give you more flexibility with cost management in the short term, until you are able to replace the lost customer.

Diligently Manage Overhead Expenses, Even When Times Are Good: 

Do not commit to long-term expense obligations when you can avoid it.  You should make every effort to match your contractual cost structure to your contractual revenue structure.  If they get out of whack, a company can be put in a position where they are paying for services and products they do not need.  In other words, if your customers pay you with fixed price contracts, you should make every effort to negotiate fixed price contracts with your suppliers, or at least insert contract language that cap the costs at a certain point, if reached, you have the opportunity to make an agreement for the additional needs.  This action would help you manage the pricing risk and ensure a minimal amount of margin.

Risk Management: 

There are risks in any business and you should understand the pitfalls in your particular type of enterprise.  What is the worst-case scenario?  What is likely to happen?  Be proactive and take steps to mitigate these risks.  The approach you need is a combination of active business management and insurance.  You diligently manage daily risk and you buy insurance to manage the worst-case scenario.

Borrow Money When Times Are Good: 

As a general rule, banks do not lend money to troubled companies.  When times are good, you should be developing a good banking relationship.  Take out a line of credit, even if you do not need it.  It can be used to help with seasonal cash flow issues, or be there for when there is an unexpected cash flow shortfall.

Seek Outside Advice from the Experts: 

For many business leaders, this can be a hard step to take, but outside expertise can be a valuable key to maintaining success and growing your business.  Look for opportunities to access expertise outside of your own business to learn what is happening in other similar companies. Here is where networking with fellow business owners and the various individuals working in fields that support them offers a wealth of current, “on the ground” information.  It’s a chance to possibly learn something new that could that could be adapted to further benefit your clients.  Even if you do not need to engage outside help now, it is a good idea to network and have qualified problem solvers on standby to help when needed.

CFO Shield in the business of helping small business to understand the market place, create the strategic plan, execute that plan, and achieve the prosperity that is your goal.  We leverage our offerings and enable small businesses to solve problems and share in the same economies of scale that larger companies enjoy.  We have the experience needed to create custom solutions to help small business owners better manage their back office and help them formulate strategies to adequately manage working capital, thereby ensuring stability and prosperity.

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