The Number One Cause of Business Failure (and How to Avoid It)
By: Jessica Myers, CEO
Of all the small businesses that fail every year, 82% of them fail because of cash flow problems. And most of them don’t even realize it until it’s too late. To anyone on the outside, the obvious question arises—how could they not know? The answer lies in the quality of their bookkeeping. It’s easy to assume that if sales are steady, business is good. How can the company be doing poorly when it’s growing every month? When owners don’t have a clear picture of the money coming in AND out of their business, they set themselves up for failure.
Low cash flow is a symptom of a variety of problems. It could be the result of late client payments, overbilling and transaction errors, fraud, or expenses. And by the time you have cash flow deficits, the problems have been there for a few months or more, making them even more difficult to correct. The solution? Better bookkeeping. This means monthly reconciliations, expense tracking and reporting, accounts payable and receivable, budgeting, and payroll—just to name a few.
The first major step in determining if you have cash flow issues–and what they are–is completing a reconciliation and creating a budget report. For some business owners we’ve worked with, the first round of reconciliations and budget reporting comes as a shock. Anyone who has estimated their budget and then set up a system to record and track the real amounts can relate (I spent how much on happy hours and fitness classes this month??). From there, you can identify existing or potential problem areas and start fixing them.
Your books need to do more for you than provide a monthly income statement and balance sheet to stay ahead and maintain healthy cash flow. That’s what’s referred to as cash basis bookkeeping. Cash basis doesn’t include unpaid bills or uncollected invoices. It also doesn’t include open credit card balances or your equipment and bank loans.
Accrual bookkeeping does track those things and answers these essential questions:
- How much did you sell in the last month, three months, and six months? What is your sales trend?
- How long does it take to get paid by your customers? Are they taking longer than 30 days? If so, that’s a problem.
- How much did you spend the last month, three months, and six months? Are you keeping up with your bills?
- Are you making a profit or losing money?
- What are your assets and liabilities? Can you meet your current obligations? How about your long-term commitments?
- How much can you safely pay your employees (and after them, yourself)?
- Do you owe sales tax, payroll tax, or excise tax? Are you up to date on your tax obligations?
It only takes a few cash flow shortages to set off a chain reaction that upsets customers, suppliers, and employees. And you can’t accurately determine your cash flow or the health of your business until you start doing your bookkeeping consistently.
Quality bookkeeping takes time. As a business owner, it’s probably time you don’t have to spare. If you’re looking for a way to manage your finances while making your business more successful, try us out. And if you only have a few questions before tackling your bookkeeping, get in touch. We love helping fellow entrepreneurs out and don't charge for advice.
Source: Small Business Failures, Jessie Hagen, U.S. Bank, 2011