Everybody seems to like lists so here is my list of the Top Five Financial Problems I find in small businesses. These are issues I see repeatedly when I go into help a small business.
The most common problem in small businesses, big businesses, non-profit organizations, everywhere, unequivocally, Number One with a bullet, is….
#1 Cash Flow
Cash flow problems or insufficient cash is so common it is almost like the dark matter that holds the universe together; it is everywhere. How many businesses have too much cash? Virtually all businesses are challenged by cash flow that is less than optimum. If you talk to non-profit organizations, the problem is the same.
Identifying this problem is simple but poor cash flow is really a symptom of a deeper problem and sometimes that isn’t so simple to identify. Poor cash flow can be due to a long cycle on collecting receivables, too much cash tied up in inventory or a myriad of other things. But the most common root cause for poor cash flow is poor profitability.
The next four of my Top Five list of most common financial problems in small business are below.
#2 Poor Profitability
If a company has good profitability but poor cash flow, usually we can manage that problem by short-term borrowing. But poor profitability needs to be rooted out at the core and eliminated. There are a lot of reasons for poor profitability and usually it isn’t just one issue but several.
One of the most common reasons for poor profitability is lack of sales or sales which are too low. That’s a pretty obvious one. Another root cause of poor profitability is underestimating costs. Almost always I find that owner/operators think their costs are lower than they actually are. This most commonly occurs in the area of labor where the true cost, including all the taxes and benefits, is often misunderstood. Still another source of poor profitability is overhead that is too high for the size of the business. This often happens when a company staffs up in anticipation of growth and then the growth is slower than expected.
#3 Poor Information
Poor financial information is related to the problems mentioned above. If a company doesn’t know what their gross margin is, or doesn’t calculate it correctly, they aren’t able to quantify their value proposition. Inability to calculate gross margin often is the result of not distinguishing between direct labor and indirect labor. If you’re in the service business and don’t make this distinction, you’re not going to be able to get meaningful information from your Income Statement (P&L).
Another part of poor information is having financial records that are not on the accrual method of accounting. Cash basis is good for paying taxes but you need accrual basis statements to accurately measure your performance for a period of time.
Finally, accurate financial information isn’t enough. It needs to also be timely to be helpful to those who rely on this information to run the business.
#4 Working in the Business, Not on the Business
This is another common problem of the small business owner/operator. Many business owners don’t really own a business so much as own their job. By working busily in the business they aren’t able to objectively look at the business and see what potential it has. The goal is to get the owner/operator to step back, get out of the day-to-day, and work on the business. This means a longer term viewpoint and it means delegating to others. Not easy but worth it.
#5 Undercapitalized
This is another common problem in small businesses. Often businesses are starting with insufficient capital. Or the business has growth opportunities that are difficult to realize without upfront investment. This is a more difficult problem to solve and sometimes it can’t be solved. Building a business by reinvesting after-tax profits is slow. Sometimes that’s the only way. But the business owner should explore various sources of capital. For example, maybe a vendor will provide you with extended payment terms if you explain the circumstances in advance. Maybe employees will accept some of their compensation on a deferred or contingent basis. Maybe suppliers will provide inventory financing that you can’t get from your bank. Getting creative here can sometimes produce significant results.
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