Watching out for red flags (Part 1)

BUSINESS evolves on three fundamental pillars–strategy, structure and staffing.

Without one pillar, the whole ecosystem collapses. Entrepreneurs have the tendency to cut the process short. It is with certainty that they will end up growing the business and will pay the price of losing the business by default. And it’s all because of a heavy reliance on “gut” or “eyeball” management.

The current environment is fraught with dangers and all entrepreneurs will face the possibility of failure. And “popular wisdom” holds that failure is not only possible but probable for the small business owner seeking to launch his or her own enterprise. It has long been said that four out of five new businesses fail within five years of their establishment.

In an online magazine referenceforbusiness.com, business failure is defined as the closing of a business that results in financial loss for at least one of the business’s creditors. An associated term, business dissolution, refers to the formal termination or closure of a business as well, but with dissolution, financial loss (for the business owners or for the business’s creditors) is not necessarily a part of the equation.

Lots of small companies go out of business for reasons that probably shouldn’t be called “failure”. The owner may have gotten bored, may be disappointed with the returns, or may simply want to try a greener pasture. Nonetheless, thousands of small business ventures do fail every year. “Companies stumble for many reasons,” observed Clyton Christensen in Across the Board.

“Among them bureaucracy, arrogance, tired executive blood, poor planning, short-term investment horizons, inadequate skills and resources, and just plain bad luck.”

These factors—as well as myriad others—can have a debilitating impact on an operation, as many small business surveys will attest.

Failure to heed the warning signs

Most small business failures do not come out of the blue. Certainly, business failures that result from catastrophic natural disasters or the sudden death of a key business member cannot be anticipated, but most businesses expire as a result of more mundane factors.

New customer complaints and surges in returns are often early warning signs of operational problems. Basic financial tools such as balance sheets and financial statements, meanwhile, can be very helpful tools in helping business owners diagnose what is ailing their company.

Systems may be used in alerting the owner or executive to critical areas in his business so he could strengthen his management technique through some form of financial preventive medicine. A review of the following critical areas, from which danger signals may emanate, will alert business owners to their soft spots. Below are early warning signs that can escalate into clear and present dangers for the business:

Cash Management

A good entrepreneur should know where company funds are at all times. He/she must keep an eye on cash flow — the lifeblood of the business. Many elements such as payroll, equipment and supplies, etc., are predictable to the extent that they can be planned and provided for by means of an expertly prepared cash flow forecast.

Study what activities are not contributing their fair share to the maintenance of cash flow; these should be eliminated.

Understand what it takes to get a revolving line of credit before you start your business. It’s always easier to get money when you don’t need it, so don’t wait until you’re desperate. Develop your business plan using conservative projections and don’t be overly optimistic. Profitable, fast-growing businesses can also run into cash crunches that can ultimately lead to bankruptcy. That’s why ongoing cash-flow analysis—tracking the money coming in and going out of the business—is a must.

A business executive who is beset by multiple difficulties and responsibilities may call on a turnaround expert or coach to help him chart his needs — what to expect on the basis of current operations and how to monitor the cash flow to spot trouble as soon as it starts.

Concerns about accounts receivable

As interest rates rise and loans become harder to get, smart customers seek financing from suppliers by simply paying bills less promptly. Did you or your sales people ever surrender to the temptation to make a sale to a known credit risk — just for the sake of a sale? Do you have a collection procedure? Do you need a factor to smooth out the peaks and valleys of your cash flow, and for protection against bad debts?

Like the biology of plants, something is either growing or dying. Sales income is used to pay for expenses, so there is a clear financial impact of not having as much sales money available to pay for expenses. There is no better barometer of market/customer acceptance than revenue.

To be continued…

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