Running a business is not for the faint of heart; entrepreneurship is inherently risky and avoiding financial hurdles seems sometimes imposible. Successful business owners must possess the ability to mitigate company-specific risks while simultaneously bringing a product or service to market at a price point that meets consumer demand levels.
We all know about the high probability of businesses failing in the 1st few years. 20% fail in their first year, and about 50% of small businesses fail in their fifth year. Here are some of the reason’s businesses fail and how to avoid it:
One of the primary reasons small businesses cannot sustain their business operations is because they do not have the cash flow/liquidity to stay operational.
So first, what’s cash flow/liquidity? It is the amount of cash that the company receives or gives out by way of payments. This discounts any cash you might have that is tied up in assets like inventory or equipment.
For example, suppose you have 50 percent of your financials locked in inventory, another 20% locked in overhead payments and 20% for ads. In that case, you have only 10% of your cash liquid to try something new. This reduced cash flow means you have less cash on hand to invest in your business which can easily hamper your innovation initiatives and let the competition provide more value to the clients.
How can you avoid this?
Attention to Financials.
While looking at the big picture, you might have projected healthy cash flow models. However, it is crucial to track the day-to-day costs of running the business to keep on top of any potential funding shortfalls.
Taking time and effort to make better forecasts will help with budget management while running the company day to day especially in terms of daily expenses.
If the company is physical product based, the owner should also look at lowering inventory holdings. Just-in-time inventory ordering and drop shipping are additional ways you can further lower costs.
Alternatively, you can look for financing to cover early-stage business growth to cover cash flow issues until the business becomes self-sustaining. Debt financing and equity financing are two typical forms of financing you can do at a small business level.
Debt financing means borrowing money and promising to pay it back with interest in the future. While Equity financing means someone is putting money or assets into the business in exchange for some percentage of ownership. Let us quickly look at the pros and cons of both.
Advantages of Equity
Less risk: You have lower risk with equity financing since you do not have any fixed loan payments to make.This is helpful with Startup businesses that might not have positive cash flows during the early months.
Available despite Credit problems: If you have credit issues, equity financing may be the only choice for funds to finance growth. Even if debt financing is offered, the interest rate may be too high and the payments too steep to be acceptable.
Cash flow: Equity financing does not take funds out of business. Debt loan repayments take funds out of the company’s cash flow, as we had just mentioned, reducing the money available to finance growth.
Long-term planning: Equity investors do not expect to receive an immediate return on their investment. They have a long-term view but face the possibility of losing their money if the business fails.
Disadvantages of Equity
Cost: Equity investors expect to receive a return on their money. The business owner must be willing to share some of the company’s profit with his equity partners. The amount of money paid to the partners could be higher than the interest rates on debt financing.
Loss of Control: The owner must give up some control of his company when he takes on additional investors. Equity partners want to have a voice in making business decisions, especially big decisions.
Potential for Conflict: All the partners will not always agree when making decisions. These conflicts can erupt from different visions for the company and disagreements on management styles. An owner must be willing to deal with these differences of opinion.
Advantages of Debt
Control: Taking out a loan is temporary. The relationship ends when the debt is repaid. The lender does not have any say in how the owner runs his business.
Taxes: Loan interest is tax-deductible, whereas dividends paid to shareholders are not.
Predictability: Principal and interest payments are stated in advance, so it is easier to work these into the company’s cash flow. Loans can be short, medium, or long term.
Disadvantages of Debt
Qualification: The company and the owner must have acceptable credit ratings to qualify.
Fixed payments: Principal and interest payments must be made on specified dates without fail. Businesses that have unpredictable cash flows might have difficulties making loan payments. Declines in sales can create severe problems in meeting loan payment dates.
Cash flow: Taking on too much debt makes the business more likely to have problems meeting loan payments if cash flow declines. Investors will also see the company as a higher risk and be reluctant to make additional equity investments.
Collateral: Lenders will typically demand that certain asset of the company be held as collateral. The owner is often required to guarantee the loan personally.
When looking for funds to finance the business, an owner must carefully consider the advantages and disadvantages of taking out loans or seeking additional investors. The decision involves weighing and prioritizing numerous factors to decide which method will be most beneficial in the long term.
But remember! A missed opportunity often ends up costlier than an expense saved.