How To Save A Small Business From Bankruptcy In The First Few Years
Businesses are fragile in their early years. Their client base may not be large, their processes not mature, their capacity not high, and their ability to weather any storms low.
Early in their lifecycle, businesses may not have robust systems. Consequently, there may be heightened reliance on good leadership (not that leadership is any less important in more developed businesses).
Businesses, in general, are prone to failure and bankruptcy, and it is strong leadership that prevents that. This strong leadership often entails hard work, dealing with risk and harsh internal and external pressures, and making hard but necessary decisions.
Being proactive and meticulous is crucial
When starting or growing a business, even one mistake can erase so many things done right. Mistakes can be disproportionately costly, and thus a successful business leader must be meticulous and take care of all the details.
The devil often lies there. Minor issues can quickly develop into severe problems that may lead to bankruptcy. For that reason, the earlier you address problems, the less likely it is for your business to fail.
Think of your business as a person. That person may be healthy or sick. The earlier you provide treatment (or better yet, prevent illness), the better.
Top reasons why businesses fail
Despite optimism bias among some business leaders, businesses do fail. Here are some of the top reasons why they do so:
Poor or no market research
Professor of Marketing Philip Kotler defined marketing as "meeting needs and wants profitably”. The key two words in his definition were “needs” and “wants”.
If your product or service does not satisfy a real need or want, then the business case for your product is weak.
Moreover, people should be willing to pay for your product a price that ensures you make a profit. Remember, people vote for products in the market with their money, and you should make sure that the product you are offering them is compelling enough to earn their votes.
To be on the safe side, you need to rely on evidence rather than assumptions. Carry out structured and organized market research to uncover hidden needs and collect data about what customers want.
You can use questionnaires, surveys, interviews, and focus group discussions to gather data and then analyze it.
You can also hire a market research company to perform this task. Although this may be costly, it can save you large sums of money spent on an unfounded idea.
Rule of thumb: Rely on verified data to the fullest extent possible. Data-driven decisions tend to produce better outcomes and align people behind them more easily.
It also often helps to introduce a prototype early on. This can help you test the product and get feedback.
The chances are that your product won’t be successful from the first attempt - not even the third maybe – but you can only succeed after a few rounds of feedback from potential customers.
Once you have a successful product with a strong business case (big and growing market) behind it, it will be a lot easier for you to find a lot of investors who are willing to finance your company, making it easier for you to expand.
Insufficient financial planning
If you meet with a lot of entrepreneurs, you will often hear from them that the costs will be double or triple what you had expected.
There are many techniques that you can use to increase the accuracy of your estimates. A famous one is the three-point estimation method. To estimate the cost of something by using this technique, you need three estimates of its price.
For example, if you want to buy a computer, you need an optimistic (O) estimate, a most likely (M) estimate, and then a pessimistic (P) estimate. The computer can cost $500 (optimistic), or $1000 (most likely), or $1800 (pessimistic).
Then, you estimate the cost of the computer by using this formula: E = (o + 4m + p) / 6. You give extra weight to the most likely estimate to ensure you are balanced. Based on the equation, a computer is estimated to cost $1050.
This method ensures that you are not way off the mark in your estimates when developing the budget and that you do not need additional reserves.
Developing your budget is one side of the equation. The other side is working on revenue projections.
Making financial projections about sales and revenues can be even harder than estimating your budget because it is associated with more uncertainty. With this task, you need to forecast sales while taking into consideration various factors that lead to fluctuations in sales volume, such as seasonal factors, among others.
Moreover, you need to develop a forecast cash-flow statement to ensure you can pay your debts as and when they are due. The timing of incoming payments is as crucial as the amount of those payments.
Rule of thumb: From an accounting standpoint, you should ensure that your assets always exceed your liabilities by a good margin. If this margin is shrinking, it should be a warning sign to you.
Finally, after you have developed both the budget and revenue forecasts, you need to perform a break-even analysis. It would be wise to think of the break-even point as your level of risk.
A higher break-even point means that there is a higher risk of not meeting the target and vice versa.
In addition to the above, remember that every business-related decision you make impacts your financial bottom line. Therefore, taking care of other aspects of your business (such as quality, HR, research, and others) will directly or indirectly determine whether you earn or lose money.
Thus, financial management encompasses more than just finances. It is a subset of all business areas.
Taking on loans and investing in unsustainable infrastructure
Businesses need capital to operate and produce economic benefits. But this capital comes at a cost. The cost varies depending on how your business is financed (loans, shares, VC funded, money from family and friends… etc.).
There are implications for the type of capital you use. Loans, in particular, require a high degree of commitment since you will be required to make principal and interest payments regularly.
Financing your business through loans is often preferred at later stages of growth when you have capital buffers to offset possible fluctuations in revenues. But if you have chosen to take loans early on, then you need to be extra diligent and careful.
Loans are a double-edged sword. They can help give your business a boost, but they are a liability. You need to carefully study your ability to withstand that liability.
Again here, relying on data can help. When using your loan to buy assets, you need to ensure that those assets will have a higher yield than cost. Spending money on a technology that becomes obsolete quickly is not a prudent choice.
The same goes for spending money on infrastructure that requires a lot of maintenance. The solution here is to conduct a feasibility study. This study reduces risks to a large extent and saves you from potential bankruptcy.
Loss of employees and high onboarding costs
Many businesses struggle with recruitment. This is especially true in industries where there is a high employee turnover rate (such as the hospitality industry, for example). Yet, you should expect a standard low turnover rate in most industries.
The problems for business leaders often appear when this turnover rate increases. When this happens, it would be wise for business leaders to check their organizational culture.
They can do so by conducting employee satisfaction surveys, which would uncover some blind spots for managers and help them address issues they were not aware of.
As for onboarding and training costs, you can rely on many technical tools to automate your training. You can prepare a set of videos that help onboard and train new employees, or you can assign senior employees as coaches to ensure knowledge transfer happens quickly.
There are many digital tools that ensure you do not pay much to hire or retain good staff.
Legal issues and high legal fees
Lack of knowledge about the laws that can impact your business is costly. Making a product similar to one that is protected by a patent can expose you to an IP infringement lawsuit, for example.
Failing to protect your employees from workplace hazards, or even failing to meet health and safety requirements can also expose you to fines or other penalties.
Moreover, we hear more and more about businesses and governmental organizations that are failing to protect sensitive data about their clients or employees. There are laws pertaining to every business area, and you need to be aware of them.
Researching laws and regulations, or consulting an attorney about matters you are unsure of, can help reduce legal risk and protect you from avoidable legal expenses.
The importance of business continuity and downtime planning
The current coronavirus outbreak has exposed almost all businesses to severe stress tests. As a result, it has become imperative for businesses to adapt and shift their operations to the digital landscape.
The implication is that protecting your data is now equal to protecting your business. Exposing any of your databases (including data about customers, vendors, employees, payroll, finances, etc.) to vulnerabilities will likely grind your entire business to a halt. The impact is too harsh to ignore.
Therefore, you need to have backup copies of your data in a safe place. Better yet, you need an overarching strategy to protect your data during hard times. This often requires nothing but a few steps that are small in size but large in impact.
Regardless of whether your business is large or small, you can expect it to be stress-tested sooner or later. Thus, you need to develop and monitor the tolerance of your business to different stressors regularly. The more proactive you are, the better the chances of survival.
In the digital age we live in today, data has become vital for all business functions, both in conditions of stability and crisis.
If your data is well-protected, you can restore operations quickly, minimize disruption, and prevent bankruptcy. In times of stability, data helps you make intelligent, evidence-based decisions and expand your business in a balanced way.
Guest Submission by Joe Peters. Follow him @bmorepeters.