Why Small Businesses Fail - Part 1

  • By John Scharbach
  • Published 3/1/2016

Why Small Businesses Fail

New businesses fail. A lot. According to the SBA, one third of all businesses with employees fail in the first two years, and one half fail in the first five years. In other words, the first few years are extremely volatile.

But why?

There are plenty of lists for the “top 7 reasons for business failure.” Operator inexperience. Location. Product-market fit. Lack of credit planning. Yes! Those are all true. But the ultimate small businesses fail—that is, close involuntarily—is because they run out of money.

That happens for one of two reasons.

First, small businesses run out of money because they can’t find a viable business model. In other words, the business does not make money. Businesses without a viable business model invariably run out of money, the only question is when.

Second, small businesses run out of money because they don’t plan their cash flows. That’s a fancy way of saying that they are hit with either an unexpected expense or an unexpected revenue interruption, and the cash isn’t there to meet the need.

Cash-flow problems are more common than you’d think. Depending on how you account for it, they are either the number one or number two cause of business failure, according to SBA studies. In other words, the most effective way—perhaps the only way—to ruin a fundamentally sound business is poor cash-flow planning.

Cash-Flow Management

So how should businesses plan their cash flows?

First, pay attention to your monthly cash flows. Profits are nice, but profits can’t pay the bills. Annual revenue is nice, but annual revenue doesn’t make monthly payroll.

Second, keep cash on hand. Keep a sizable cash cash reserve—either in your bank account or at your fingertips. You never know you need money until you do, and then it’s usually too late.

“Cash is king.” And the faster you get on board with that idea, the less likely you are to have cash-flow problems.

We suggest a three-prong strategy for cash-flow management. First, make money. Second, don’t take too much money out of the company. Third, learn to use debt as a cash-flow management tool.

Rethinking Debt

Too many business owners think of using credit only when they “need money.” This is obviously wrong. Never use debt to prop up a failing business. If your business is insolvent, debt will only make the problem worse. Debt is for healthy businesses, not failing ones.

This mindset, we think, is not only wrong, it is a primary cause of unnecessary business failure. This is because responsible credit is a crucial protection against cash-flow problems. It is like an insurance policy against an unforeseen cash crunch.

If you deliberately forgo that insurance policy, you’re setting yourself up for trouble. The adage “if you fail to plan you’re planning to fail” is nowhere truer than cash-flow management. No one plans to take a high-interest loan from a sharky lender. They just back themselves into a corner by not planning ahead.

We get it. Debt can be scary. But it doesn’t need to be. We challenge you to think about debt differently. 

Debt capital is an extremely effective cash-flow management tool. It’s like borrowing money from your fat months to pay for your lean months. You pay a small risk premium in monthly interest, but otherwise you’re just shifting your own money from the future to the present. This allows you to smooth out your cash flows.
You should be much less afraid of debt and much more afraid running out of money.

But many business owners make a crucial mistake: they wait until they need money to ask for money. This is like trying to buy car insurance after the wreck. The hardest time to get money is when you need money. Here’s how we summarize this truth at Able: the best way to avoid a high-interest loan tomorrow is a low-interest loan today.

Schedule your FREE business consultation today.

Keep up with our team

Sign up for our Monthly Newsletter

[[ errorMsg ]]

Thank you for joining our community. Please look for an email from team@ablelending.com.