According to the U.S. Bureau of Labor Statistics, an astounding 75% of businesses fail in the long-term out of which 38% become the victim of running out of cash and failing to properly manage their money. But that doesn’t stop founders from starting their own entrepreneurial journey.
It was reported in 2020 that more than 40 million small businesses were operating in the United States alone. So, why is there a high percentage of businesses running out of cash? Narrowing it down, these are the top reasons why small businesses run out of cash fast:
- Aren’t equipped to make informed and beneficial financial decisions.
- Not knowing where the business requires spending.
- Spending more to make more without proper planning.
- Hiring too many people and not being able to pay employees.
Let’s dive more into detailed financial challenges that small businesses and startups typically deal with and how to overcome them to beat the odds
Lack of Financial Planning
If You Fail to Plan, You Are Planning to Fail” — Benjamin Franklin
Running a small business requires flexibility and constant change. However, this does not mean you should abandon financial planning.
You should be able to allocate the funds to several sectors – marketing, hiring, development, ads, etc – and should have enough funds until you plan your next raising round or more than enough in revenue. That being said, it’s advisable to follow one of the two common types of planning.
- 12 Month Forecast
- 13-Week Cash Flow Plan
By creating a financial plan, you’ll know where you’ll be spending and how much you’ll need to reach certain milestones. Without a proper financial plan, the future of your small business is in danger and the results can be detrimental.
Earning Profits but Losing Cash
It is always exciting when your small business starts pulling in steady profits. It is easy to drive financial decisions based on these profits, but in a small business, this is rarely the best way to make financial decisions. There is a difference between Net Profit and Cash Flow – we oftentimes refer to this as the “Cash Flow Spread”.
Profits do not indicate Cash Flow. Expenses such as Owner Draws and loan repayments are examples of items that affect your cash but not your profit. When you base your decisions strictly off of profits, you are missing the Spread and this oftentimes can have detrimental effects on your business.
(Not) Planning For Taxes
Raise your hand if you prioritize saving for taxes! Basic and simple tax preparation is imperative to running a successful small business. According to TaxesMastered.com, 85% of businesses overpay taxes which means planning for tax time is a common place where businesses make mistakes. As a general rule of thumb, it is advantageous to set aside 15-20% of your Net Profits for taxes but consult a professional for your effective tax rate to make sure you are covered.
An example: Let’s say you make $30,000 in Net Profit and you pay yourself that entire amount as your Owner Draw (salary) for running your business. While your profit is still $30k, your Cash Flow is now $0 but you still owe $4,500 (at 15%) in taxes. Saving each month for taxes is part of that Cash Flow Spread that often gets missed. Without proper savings, this can quickly present itself as an issue for your business.
Relying on your Bank Balance?
It can be fun to open your bank account and check your balance – especially after you close that big sale. In our estimation, 99% of small business owners drive their financial decision-making off of their balance. Your bank account tells you what you have, not what you can sustainably spend.
There are many short and long-term financial commitments involved in running a small business and your bank balance is not a good representation of your financial health. Expense and investment decisions should be made in reference to your financial plan combined with current revenue.
Improperly Managing Books
Bookkeeping is imperative to running a successful business. If you are not managing your books and finances properly, you don’t have an informed idea of where your business stands financially. This results in a fallback to decision-making based on your bank balance.
Bad data = bad decision-making.
Using a professional service, such as Pinto Financial, guarantees you are getting accurate financial data, leading to quality decision-making. Bookkeeping is the foundation for financial success, make sure your foundation is solid before you start building on it.
Poor hiring tactics
“Hire Slow, Fire Fast.”
A bit ruthless some might say but personnel decisions can make or break your business. Whether you are hiring contractors or full-time employees, each person that you are committing to needs to fill a need or skill that will improve your business.
We say hire slowly because you want to make the right decision on the first attempt. It is both time and financially efficient to spend significantly longer hiring the right candidate than to jump to the first or second applicant because you are drowning in work. Hiring is expensive and having to let someone go and repeat the process because of impatience only makes things worse.
In the end, you’re not just paying that person but investing in them so that they can help you increase the ROI.
Overspending
As the motto goes: “You’ve got to spend money to make money.” But take that with a grain of salt. If you have a solid financial plan in place you’ll be able to know exactly what you can spend and how to spend it. You’ll know the instant you’ve blown the budget.
While this is an extension of overhiring, there are so many other places a business owner can use their hard-earned dollars. COGS, advertising, software, and the list goes on. Consult your books, look at your plan and most importantly, adjust as time goes on and you’ll be on the road to success.
Accumulating Credit Card Debt
Here at Pinto, we will Never recommend using credit cards as a form of debt – ever. Period. Credit card interest rates are borderline predatory and repaying credit card debt feels like being in an endless loop.
Here’s what we do recommend for credit card use:
- Use it as you would a debit card. Spend what you have and pay off your statement balance (or full balance) each month.
- If you are struggling to find a reasonable loan, find a card with 0% interest for a certain period of time, typically 6 to 12 months. This buys you some leeway but you absolutely must pay off the entire balance before the promotional 0% interest runs out. Typically credit card companies will assess interest retroactively to the date of the original purchases as opposed to when the promotional rate ends. This can easily be the difference of thousands of dollars of interest payments – begin the downward spiral of credit card debt!
Investment or Accumulating Loan Debt Without A Plan
Investing and taking out loans are often necessary for running small businesses. However, they can run you right into the ground if you don’t have a plan in place to pay them back. Here are some important considerations to make before taking on debt:
- Bootstrap or Self-Investment: Most small businesses start with the business owner using their own money or capital to get their business off the ground. Entrepreneurship is a big step and can be scary for most people. Is it worth investing your money with no business plan?
- Debt: Responsible debt is a great financial tool to help your business get off the ground and gain profitability. A sound financial plan will show you when that debt will be paid off and how it will help you break even and eventually make profits month over month.
The Take-Away
Running a small business requires making frequent financial decisions. It is all too common that business owners to make poor decisions based on a lack of expertise and understanding of their financial health. This is where Pinto can help. Reach out to us today for a free consultation to help you set your small business on the path to success.
*Please seek professional and certified advice regarding all tax-based decisions.