Understanding Why Businesses Fail
If you get anything out of this blog, know there’s 3 reasons why businesses fail: it’s because of cash flow, cash flow, and… yes, cash flow.
First, to be clear on one thing, profits don’t equal cash flow. The situation where profit and cash flow are at odds is very common for a small business which must invest in assets in order to grow. The reasons can always be seen on the balance sheet.
Cash flow measures the ability of the company to pay its bills. The cash balance is the cash received minus the cash paid out during the time period. This is where things can get tricky with cash flow management.
According to a U.S. Bank study, 82 percent of business failures are due to poor cash management. Small Businesses owners and CEOs need to make decisions that sometimes can cause negative long term results with their business’ cash flow.
What are some of the bad decisions business owners make because of Cash Flow problems?
In some cases, business decisions lead to cash flow issues. Once you are in the cash flow crunch, your decision making ability is further impacted by lack of resources and fear. This can lead to bad decisions in three main areas of your business:
Pricing: You price your jobs lower, or offer discounts/promotion to get any job, which can cause margins to be lower than your target margins causing cash flow issues.
Cash Flow problems cause you to not look at your pricing model or experiment with value pricing because you are too scared to lose business.
Hiring/Firing: You hold off on hiring because cash is tight but you have the work coming in, and due to lack of proper staffing, that affects quality, timing, and customer service. Which then causes negative reviews and unsatisfied customers.
You hesitate on firing because the cost of searching, replacing, re-training, etc. is greater than struggling along with a mediocre employee.
You keep bad clients because you need the cash flow, but bad clients either don’t pay timely, cause service team pain, or they are not meeting your target profit margins.
Spending: You don’t spend in places where you should spend because you feel like you can’t afford to. For example, with your business marketing, you may not do a marketing campaign because you don’t want to spend the money and are too worried about the ROI. In Sales, you don’t hire because you don’t want to spend the money to pay someone else. You don’t take advantage of opportunities or take educated risks for the benefit of your business because of costs that may be involved.
In this blog, we’re going to cover those issues and discuss how to make actionable decisions on pricing, hiring/firing, and spending. But first, watch this video to learn How to Improve Business Cash Flow:
Decisions that most affect Cash Flow and what to do about it
Many businesses have cash flow problems because they don’t hit their target margins, and they’re not aware that they’re not hitting them. Then, if you don’t have the necessary profits and your client pays you in 30 days, and payroll’s today, you’re in trouble. This is called a working capital requirement. You need working capital to pay payroll before you get paid your final payment.
The number one reason businesses fail because of cash flow is because they are pricing poorly. How well you price your products/services and the margin it produces is the key to maximizing cash flow.
You should put more thought into optimizing your pricing model, as this will have the biggest impact on profits over anything else. Consider the pricing model that fits best for your business: Value-Based Pricing, Fixed Fee, Time & Material, or Milestone Driven.
The job costing process tracks the true costs to deliver a service or job, so a business can charge the right price to achieve its target gross profit margin. To get a more accurate view of job costing for pricing, make sure you engage in time tracking to see if you’re allocating the right fees for the time spent on the job. Why Job Costing is Essential for Small Business Owners.
Also, spend time understanding your true labor cost in order to optimize your quotes or pricing. Being able to know the true amount of time needed on every job and showing the value from those services in your proposals will help justify that higher amount.
Cost of Goods Sold (COGS) is an important number to help you with your pricing because it’s used to calculate gross profit on a job.
The only way that true job costing works is to know that nothing is slipping through the cracks.
Cash flow can quickly go in the wrong direction if you’re pricing your services poorly. If you don’t have enough profit to generate the working capital needed to pay for supplies, payroll, and bills, for instance, trouble is not far off.
When you’re fixated on getting the next project and not looking further ahead, you’ll do anything to get cash in the door – but it’s often at lower margins which causes lower profits or even losing money on a job.
Although hiring and firing are equally difficult, it’s a necessary step, and having the right fit increases your profitability. Who you hire or fire is the second most pivotal decision concerning cash flow. You need employees who will fit the culture and are engaged in working toward the success of your business. If this isn’t happening, then you’ll have to take the proper steps to fire employees who aren’t a good fit for the company and are a cancer to the culture. People who aren’t happy in their jobs will inevitably cause negative effects to the long term success of your business.
Before hiring any new staff, evaluate what clients should be fired and increase your revenue and your profits by replacing the lowest margin clients with higher margin clients.
If you keep low margin clients out of fear of losing cash flow, or not being able to replace them with a higher margin client, you will kill your business. Don’t be afraid to fire low margin clients – after all, Low Gross is Grief (LGIG). This means your lowest margin clients give you the highest amount of grief and eat up your staff’s valuable time. Eliminate those clients, and you’ll have a happier team and a more profitable business.
All of this goes back to having a cohesive team and clientele who share the core values of your company – then, and only then, will you have a high performing team.
Here’s a big one… knowing where you spend your money. If there’s cash flow problems, Maslow’s Hierarchy of Needs comes into play, and you’re going to default back to what’s safe and secure for you as a business owner. 80% of businesses that fail do so because of cash flow, and a result of making spending decisions out of fear – usually meaning they don't invest because they're afraid to spend the money.
Short-term cash problems shouldn’t prevent you from making good long-term decisions.
If you're having cash flow problems, you can’t take advantage of opportunities that come your way. Think for example if you’re a supplier and your biggest vendor reaches out to you with a recent deal that fell through. They’ve got a huge inventory of widgets, and know you use them year-round. They offer if you buy it all at once, they’ll knock 25% off. That’s huge for you! It’s an instant competitive pricing advantage because you have lower costs. But not if you don’t have the cash to do the deal.
Also, in terms of spending, you should always take educated risks. By tracking valuable KPIs over the year, you can gather actionable financial intelligence that will help you quantify ROI and make good long-term decisions on spending.
Make the Right Decisions
No matter what your business is, having best practices and foresight in your pricing, hiring/firing, and spending will help improve cash flow and help your business succeed. Many of these factors can be achieved with the right actionable financial intelligence to see the state of your business, and where it needs improvements.