All entrepreneurs face the possibility of failure, and a good deal of “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.
Business failure is defined as the closing of a business that results in financial loss for at least one of the business’s creditors. According to business expert George Fox, the associated term is business dissolution. It 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, for instance, 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, poor planning, short-term investment mindset, 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.
Most small business failures do not come out of the blue. Certainly, business failures that result from natural disasters or the sudden death of a key business member cannot be anticipated, but most businesses tumble as a result of more mundane factors. Incessant customer complaints and surges in back jobs or 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 or her management process through some form of financial preventive intervention. A review of the following critical areas, from which danger signals may emanate, will alert business owners to their most vulnerable spots including possible resolutions that can shield the business from further harm.
No 1 Cash Is King. And therefore Cash flow management must be addressed at all times. 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 (these are cost centers) are not contributing in the revenue side but directly affecting the cash flow; they should be immediately taken out of the equation.
Understand what it takes to secure a credit line 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 owner 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.
According to business writer Brian Hill, “small-business owners are optimistic by nature, but when they make the decision to launch a new venture, they should recognize there is a chance the business will fail. The signs of failure often show up well in advance of the business entering a crisis stage, which gives the owner and the team the opportunity to take action to remedy the situation before complete failure occurs.”
Identifying these risks also triggers a reaction to improve the business. In either case, to avert eventual shutdown, the owner must immediately do an internal review of the 3 Ps, people product and the process. Believe me, you will be in for a surprise once you start probing. On a positive note, your discovery may result to real changes. It is also important that a market scan be initiated to identify changing trends in the marketplace. In my years of business and turnaround advisory in Asia, these small steps can go a long way in reversing the “signs on the wall.” The key initiative for business owners is to acknowledge that there are problems, temper the decline in sales and avert a potential bigger problem. Therefore, critical interventions in the early stages may just save your business from further damage. The first red flag to look into is cash flow management. A good business owner worth his salt must realize that business is fraught with risks, but how he can navigate these risks will determine his or her staying power in the marketplace.
No 2. Declining Sales
Success for a small business means increasing sales each year and at an ever-increasing rate. If the rate of sales growth is lower than the growth of the industry, something wrong is happening internally. As Hill highlighted, “when sales slow significantly or worse — if sales decline year-on-year, it could mean the company is in danger of failure.” The situation may be reverse by making changes to the company’s marketing and sales strategies including the process of managing accounts. Declining sales could be a result of many things, from price to product change, its relevance and appeal to customer tastes and preferences, or plain and simple bad customer service.
No. 3 Accounts Receivable
As interest rates rise and loans become harder to get, smart customers seek financing from suppliers by paying bills in phases, of course with the tacit approval of the suppliers. 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 that is fail proof? 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.
No. 4 Loss of Major Customers
A business that relies heavily on a small number of key accounts for the bulk of its sales can be in serious trouble when it loses them to a competitor. Several factors play an important part why customers suddenly change loyalty and walk to the next major competitor. Was it bad customer service? Or the competitor offered a superior product? Or was it an issue of price points and possibly better terms offered? Or it could be all of the items mentioned!
It is crucial for business owners to immediately assess and quickly identify the reasons why loyal customers are leaving and make the necessary changes to the company’s strategies to prevent the further loss of customers.
Prof Enrique Soriano is a World Bank/IFC Governance Consultant, Senior Advisor of Post and Powell Singapore and the Executive Director of Wong + Bernstein, a research and consulting firm in Asia that serves family businesses and family foundations. He was formerly Chair of the Marketing Cluster at the ATENEO Graduate School of Business in Manila, and is currently a visiting Senior Fellow of the IPMI International School in Jakarta.
He is an associate member of the Singapore Institute of Directors (SID) and an advisor to business families worldwide, a sought after governance speaker, book author and have written more than 200 articles and publications, including two best-selling Family Business books (Ensuring Your Family Business Legacy)