July 2018

Why most businesses fail

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Why do most businesses fail?

One of the leading causes – Insufficient capital. Or to be more specific inadequate cash flow or cash reserves.

However, it’s a lot more complex (and important) an issue than simply not having enough cash on hand to pay your bills or see the company through a rough spot of lower income. “Running out of money” is usually the result of several factors which have occurred over time and were ignored or not well understood.

You’ve probably heard the old adage from Ernest Hemingway’s “The Sun Also Rises” and variously attributed to Mark Twain and F. Scott Fitzgerald that there are two ways to go broke: “Gradually and then suddenly.”

Not surprisingly that’s how many businesses go bankrupt. First, they deplete their cash reserves then eat through the owner’s savings and finally use up any lines of credit such as overdrafts & credit cards.

Then in a flash it’s over.

Managing a successful business boils down to two basic skills which unfortunately are too often overlooked in the hustle and bustle of keeping all the other plates spinning smoothly:

Maximize Profit: As you’ve read in practically every business book ever published the objective of a company is not to “make money” but to “earn a profit”.

Manage Cash Flow Effectively: From the earliest stages of establishing your business it’s your duty as the company’s leader to track and manage cash. Mastering the cash flow which provides the lifeblood of your enterprise will empower you to plan ahead manage your resources better and avoid the stress of not having a clear picture of the financial wellbeing of your business. Family businesses and entrepreneurs fail for many reasons, but this is often the root cause.

The unfortunate truth is that of those that fail many will do so for completely unnecessary reasons.

Here are some cash flow rules which can help you avoid being in the dark about your finances and improve your chances for long-term success:

1. Learn to read an income statement

Also known as a profit and loss statement your accountant should be providing you with this summary of your profit or loss on a regular basis. Because the income statement encapsulates all revenues and operating expenses in a clear and concise manner it enables you to determine the overall financial performance of your business. In addition to making you a better-informed manager your income statements along with your balance sheets are essential information for securing business loans and lines of credit with banks vendors and prospective investors.

2. Give priority to income over profit

Regardless of your capitalization building a solid cash flow is better accomplished with clients who pay reliably and on-time as opposed to customers who stretch out payments, ask for longer terms or may default on their accounts, even if they place larger or higher margin orders. Pay close attention to your payment terms and be selective to whom you provide credit. Invoice promptly and clearly state terms and acceptable payment methods. Keep on top of delinquent accounts.

3. Make your cash flow forecast your compass

Just as the income statement documents all recent financials the continual use of a cash flow forecast provides visibility into the immediate and longer-term future. Calculating and revising cash flow on a weekly, monthly or even daily basis if you’re so inclined serves as your crystal ball for seeing what’s around the corner.

4. Manage your debtors and creditors carefully and sensibly

Among the benefits of the cash flow forecast is its ability to help you identify shortfalls in cash balances before they occur. The trust you have established with your suppliers and creditors is a valuable asset and one you must take every precaution to preserve. If you anticipate a cash shortfall, ask for extended credit terms well in advance to make it clear you have good financial controls in place and therefore less of a credit risk

5. Choose and use working capital wisely

How effectively you finance your working capital has a direct impact on your ability to strengthen your business’ finances and underwrite growth. There is a wide spectrum of financing options available to any business; Bank overdraft; Loans secured by business assets and/or outstanding invoices can be useful. Business and personal credit cards are also convenient and practical methods. Many businesses lease equipment such as machinery, vehicles or furniture to avoid large capital outlays and to reduce taxable income. Company-owned assets including property can be sold and leased back with similar benefits.

6. Foster a close relationship with your accountant

Your choice of accounting firm may be the most strategically important relationship in the lifecycle of your business. Rather than simply considering “the books” – an experienced and top-notch accountant will be familiar with all the strategies outlined in this article. Moreover, they should be fully qualified to implement them and use them to the best tax reporting advantage for your firm.

7. Consult with a wealth management adviser/financial planner

In addition to having a superstar accountant in your corner (if you don’t know one we do) you should consider speaking with an independent wealth management firm. Just as your business requires expert oversight to maximize opportunity your personal wealth and family’s future deserves nothing less than insightful guidance of the growth and protection of the assets you’ve worked so hard to accumulate. The number one reason why an owner won’t sell their business to enjoy retirement is due to lack of cash flow.  An initial consultation should be an in-depth and frank discussion of your current situation and your immediate and long-term goals both of which will start the conversation toward creating a wealth management game plan tailored to your needs.

To discuss any matters arising from this Briefing Note please contact Holborn Financial on 020 8946 8186.

 

This Briefing Note is provided for information purposes only and does not constitute any form of financial or investment advice. We believe the information to be correct at the time of going to press but we cannot accept any responsibility for any loss to any person as a result of action or refraining from action as a result of any item herein.

Printed and published by ©Holborn Financial Limited authorised & regulated by the Financial Conduct Authority. July 2018