In this free webinar, you’ll learn…
- Why so many small businesses fail
- How to create a robust budget in six easy steps
Proven ways to overcome cash-flow problems
Growing your business the right way — and at the right speed — is how you succeed. We’ve all seen the two extremes: Small businesses that grow too fast and collapse under their own weight, and small businesses that just never seem to take off. So let’s look at charting a middle path. Because small business owners are busy people, we’re going to move briskly today. If you have questions, we leave plenty of time — and of course, we’ll tell you how to connect with experts who can help you afterward. Let’s get started.
It seems odd that a business that has 499 employees and a business that has one employee are both classified as “small” by the federal government. As you can see, that definition covers nearly all the businesses in this country. That’s not helpful for our discussion today, so…
So for our purposes today, we’re going to talk about what’s known as VSBs. The Small Business Administration has classified these as less than 15 employees bringing in less than $1 million a year. This includes home-based businesses and businesses run by just one person. That’s exactly who we want to address today.
Regardless of their size, the SBA’s statistics show big problems for all small businesses. Namely, most don’t stick around long. While only a fifth perish in their first year, that jumps to nearly a third in year two and half after five years. After a decade, it’s 70 percent, although to be fair, that includes businesses that its owner sells off, perhaps because they need a break or want to start yet another new business.
Let’s talk for just a moment about small businesses that failed because they grew too fast. It sounds like a great problem to have. It’s not. Let’s use Crumbs Bake Shop as an example. For a time, it was the nation’s largest cupcake chain. But it expanded too fast, and the company learned that Americans love cupcakes, but not enough to eat them all the time. After growing from one store to 79 in a decade, the entire company crashed, and it was sold off in bankruptcy.
So what can we learn from small businesses that grew too fast? Well, it turns out they often fail from the same things that cause ALL small businesses to fail. Let’s review some of those real quick, before we share some tips for giving yourself the best chance of success.
Whether you’re just starting out or expanding too rapidly, overly optimistic growth projections are often the first steps on the path to doom. You need to set a range of expectations that take into account everything from new competitors to natural disasters. Then you need to constantly update those projections as circumstances dictate.
When your business grows and you can’t handle the workload, you need to hire someone. That’s a stressful decision, because hiring poorly can doom your entire business. Books have been written on this topic, so we’ll just quickly mention the biggest problem with hiring for the first time: Neglecting passion. In a small business that’s growing, you need to look beyond skills and decide if this employee wants to struggle and grow with you.
Even if your business grows slowly, this is one of the fastest ways it will eventually fail. You need to scale up not only your sales and staff, but how you keep track of your income and expenses. One common mistake: In the beginning, you meet with your accountant only at tax season. But as you grow, you should consult them more often, since they can help you study your data and make objective recommendations.
Once you’ve mastered the budgeting basics in your personal life, it’s easy to do a business budget. Let’s start at the beginning.
First, you add up your monthly revenue sources — and remember, we said revenue. Not profit. You want to include all the ways you make money before expenses are deducted.
Ideally, you’ve been in business for at least a few months, possibly a year. Why? Because you want to do this same calculation for several months, then take an average. Few businesses earn exactly the same each month, so coming up with a monthly average is important.
Now you want to do the same thing with your fixed costs, which is defined as any cost that doesn’t change with the output of your business. That includes line items like rent, taxes, and equipment. Depending on your business, you might have more or less fixed costs.
Sometimes, new small business owners confuse this term to mean, “Costs that I can’t negotiate.” That’s not true, since you can obviously negotiate your rent. But these costs remain whether your business is doing well or poorly. So for example, if you leased a widget machine and business is slow, you’re still making payments on the widget machine.
Obviously, variable expenses are the opposite of fixed expenses. Here we’re talking about things like wages, supplies, and utilities. Why are these variable? Let’s go back to the widget machine. You need to keep making payments on it, but if business is slow, you’re using it less, which means your electric bill is cheaper. You can also save on the wages of the widget machine operator.
Conversely, if business is booming, you might pay for an extra shift and run the widget machine night and day, driving up your wages and utilities but earning you more revenue.
In other words, variable costs can fluctuate with business activity. Just like you did with revenue, estimate these costs over a series of months. While most variable costs are monthly (like utilities), others can be charged quarterly or annually (like marketing costs).
A contingency fund for a small business is like an emergency fund for a family. Here again, if you handle your personal finances according to established principles, you’ll find doing the same for your business will be a breeze.
If you don’t have an emergency fund, and more than a quarter of Americans don’t, you need to start one pronto. No amount is too small to start with, and you’ll learn some principles of a contingency fund.
So what are those principles? Well, a contingency fund is all about “unforeseen circumstances.” Your personal emergency fund can cover the financial costs of a sudden illness or job loss. But for a small business, a contingency fund is often used for more than just emergencies.
For example, it can be used to replace that widget machine if it suddenly breaks down beyond all repair, or it can be used to upgrade the technology of the widget machine. So while you’d use the contingency fund if, say, a natural disaster damaged your office, you’d also use it to generally repair or improve your business.
The trick is to make sure you don’t dip into your contingency fund for typical business expenses. In other words, you don’t use this fund to cover your payroll. Your budget should already account for your fixed and variable expenses. We’re talking about big, one-time costs that either keep your business humming or can dramatically improve it.
Now that you’ve done your budget, you have the tools to create three key financial statements. One you’ve just done. That’s the P&L. Along with that are two other documents.
A balance sheet is simply a financial snapshot of your business. It’s an equation that looks like this: your liabilities plus your equity equals all your assets. As the U.S. Small Business Administration says, “The two sides of the equation must equal out.” Confusing? Hold that thought for a moment.
A cash flow statement is simpler. This highlights how much money is coming in (called cash inflows) and going out (cash outflows, of course). Cash inflows include not only cash sales but also accounts receivables you collected and loans and other investments. Meanwhile, cash outflows include equipment you bought, expenses you paid and your inventory.
While solidly built budgets and financial statements are required to be truly successful, they can’t prevent the inevitable cash-flow problems many small businesses face at one time or another.
There are several common causes for cash-flow issues. First and foremost is the obvious: You’re not selling enough of your product or service. This doesn’t mean your business is failing. Many businesses have a slow season where they’re just scraping by.
Many businesses also have a collections conundrum: Sometimes your best or newest customers are late with their payments, and you need to decide how hard to push. Sadly, that often means pushing very hard, because those payments simply never come.
Finally, there’s a situation much more within your control: Your own expenses. Are you buying items you don’t need, or can you get items you do need for cheaper?
Fortunately, cash-flow problems have more solutions than they have causes. Some are easier to implement than others. Let’s review your options.
In the old days, you had a sale. These days, you can host a “flash sale.” These are defined as ultra-brief sales that you advertise mostly through social media. They typically last for only a day. If your financial statements are otherwise sound but you need a cash injection, a flash sale might be an easy way to do that quickly.
Ask most small business owners, and they have at least one horror story about a client who owes them and pays late. Just like trying to figure out the perfect price, small business owners have to balance pushing their late payers without pushing them to their competitors.
If you need cash now, you need them to pay up. But you don’t have to harass them. Consider offering your customers incentives. If they pay early, perhaps they receive a 10 percent discount. Sure, you lose 10 percent, but you gain 90 percent. Do the math to make sure the tradeoff is worth the cost, but you might want to consider this carrot instead of just a stick.
While you’re trying to speed up your customer’s payments, try slowing down your own. Figure out how late you can go without incurring a late fee or the wrath of your best vendors. Coupled with speedier invoicing, this might cover your cash-flow discrepancies.
If not, you can always call your vendors and explain your situation. Trust me, you won’t be the first customer who’s told them they’re suffering a temporary cash-flow situation. For reliable and long-term customers, they’ll often cut you some slack.
Finally, you have the option of using other people’s money. From small business loans to small business credit cards to complex procedures with names like “invoice factoring,” there’s probably a financing solution that suits your situation and comfort level. Let’s start looking at those now.
Qualifying for a small business loan requires preparation, and there are so many variables, it’s difficult to spell them all out here. Whether it’s the amount of the loan, its length, or its interest rate, you really need to do your homework to make sure you get the best terms. So let’s cover the basics. And let’s start with SBA loans, which are backed by the federal government.
Find funding. Some of the Traditional Sources of Funding are personal savings and/or borrowing money from friends & family.
Explore grants from city/county where business is located/ check grants for minority business.
And you could consider a home equity loan, a loan from a bank or credit union, using credit cards or asking business partners to pitch in for the funding.
Now let’s review the 6 C’s of Credit. These are key factors lenders consider when evaluating your creditworthiness, and they include Character, Capacity, Capital, Collateral, Conditions, and Cash Flow.
Let’s begin by understanding what each of these C’s represents and why they are essential in determining your ability to obtain credit.
Character: Your reputation and history of managing debt, including factors like your credit score, payment history, and reliability in repaying debts.
Capacity: Your ability to repay debt, often assessed by evaluating your income, expenses, and debt-to-income ratio.
Capital: The financial resources you have available, such as savings, investments, or assets..
Collateral: Assets that you pledge as security for a loan, providing lenders with reassurance in case of default.
Conditions: External factors that may influence your ability to repay debt, such as economic conditions, industry trends, or changes in interest rates.
Cash Flow: The amount of cash generated by your business or personal finances, indicating your ability to meet financial obligations on time.
Now, let’s dive deeper into each of these C’s to understand how they impact your creditworthiness and what you can do to strengthen your position.
Character is often considered the most crucial factor in credit evaluation. Lenders assess your credit history, payment behavior, and reliability in meeting financial obligations. Maintaining a positive credit history, paying bills on time, and managing debt responsibly can enhance your character in the eyes of lenders.
Capacity focuses on your ability to repay debt based on your income, expenses, and debt obligations. Lenders calculate your debt-to-income ratio to determine if you have sufficient income to cover your debt payments. Improving your capacity involves managing your finances wisely, reducing debt, and increasing your income where possible.
Capital refers to the financial resources you have available to support your credit application. This includes savings, investments, and assets that can be used as collateral. Building your capital through savings, investments, and asset accumulation can strengthen your creditworthiness and increase your chances of obtaining credit.
Collateral provides lenders with security in case of default by pledging assets such as real estate, vehicles, or equipment. Having valuable collateral can improve your chances of securing a loan and may result in more favorable loan terms. However, it’s essential to understand the risks associated with collateralized loans, as defaulting could result in the loss of assets.
Conditions refer to external factors that may impact your ability to repay debt, such as economic conditions, industry trends, or changes in interest rates. While you may not have control over these factors, understanding them can help you make informed decisions about borrowing and managing debt.
Cash flow measures the amount of cash generated by your business or personal finances and is crucial in meeting financial obligations. Positive cash flow indicates that you have sufficient funds to cover expenses and debt payments. Managing cash flow effectively involves budgeting, monitoring expenses, and maximizing income streams.
By focusing on strengthening each of these factors, you can enhance your chances of obtaining credit on favorable terms and achieving your financial goals.
So that’s it. I know we reviewed some depressing topics today, as well as some complicated ones. But if you heed this simple advice, you have all the tools you need to be successful. This is really the hardest part, because you know your business and customers, and you work hard.
Obviously, we’ve just scratched the surface here. Running a small business is a full-time job on top of a full-time life. So while Money Never Sleeps, we hope we’ve put your mind at rest and given you the tools to explore all your options. If you have questions, don’t hesitate to ask us. We’re here to help! Thank you so much for spending this time with us! Hope it was worth it!