A reader wrote to me asking why small businesses fail. He wrote to me the following comment that I would like to address:
“With the Internet and various technologies that automate things like proper ad targeting, your main advice point is to WORK. No way around this, but if most are destined to fail, the few who manage will only spin wheels until they’re out of gas (so to speak), so building wealth is really the key to survival. Profit is meaningless if it doesn’t last, or isn’t at a minimum somehow leveraged for perpetuity.”
So let’s digest and address this reader’s comment/concern. I’ll start with an example from one of my clients.
Where Are Your Business’s Profits? What Every Entrepreneur Must Know About Profitability
My client initially called me last summer wondering if I could help him with marketing and, in turn, scaling his business.
In the early stage of our conversation, I asked him how profitable his business was in 2017 and the year to date in 2018. He advised that his company made $200,000 in 2017.
We then got to talking about how he was investing his profits. Although his business was profitable, according to the income statement prepared by his accounting firm, he didn’t know where his profits were.
He hadn’t taken any money out of the business, other than his salary. So although the income statement showed a profit, he didn’t see those dollars or know how to track where those dollars were.
I worked with my client on establishing a number of cash buckets to better manage his cash flow and then worked with him on the accounting side of his business so that he could better track the in-and outflows of cash into the business.
Back to the reader’s comment, “Profit is meaningless if it doesn’t last or isn’t at a minimum somehow leveraged for perpetuity.
Profit Is At The Core of Every Small Business
The holy grail of building a business is to establish a business that makes a profit. I have addressed this many times in multiple blog posts.
Profit should be at the heart of a business’s operation. It is germane to the business’s existence. No profit, no business.
I will make an exception to the above if you’re scaling a rapid tech-based or dot-com that will sell for many multiples of revenue in a short period of time. Otherwise, you are in business to make a profit.
And therein lies the problem.
Every Entrepreneur Needs to Understand the Accounting Fundamentals
Many entrepreneurs are so excited by the idea of opening a business, they spend so much time on growth, sales, marketing, and so on and neglect the fundamentals of accounting.
There’s a lot to know as a business owner.
I’ve often said that marketing is THE MOST important thing you need to understand, and although it is, you can’t neglect the other parts of business ownership. Accounting, and profit, are key.
So what to do?
You need to spend some time understanding the basics of accounting.
I’m not suggesting that you need to be a CPA, nor am I suggesting that you need to understand accounting as well as you understand marketing, but you need to understand things like gross margin, gross profit, net margin, net profit, and EBITDA.
You need a monthly accrued income statement and balance sheet.
You need to review these things … MONTHLY!
You need to review cash flow … DAILY.
Again, there’s a reason 80% of business owners fail within the first 18 months.
These entrepreneurs probably don’t understand the gross and net margins. Your gross margin needs to support your other fixed expenses and debt repayment.
Entrepreneur Profit Illness – Excelitis – The Excel Factor
These entrepreneurs are probably also afflicted by “Excelitis.”
That’s my term for grossly exaggerating the number of widgets they expect to sell, putting that number into the Excel document, and voila, you’ve got profit.
Even better, change the number of widgets you expect to sell from 1,000 to 2,000, and sales double. Hey, what if you make it 4,000?
Just because a business appears to work in Excel doesn’t mean that the business is a great idea or that it is necessarily viable. Just because you put the number 4,000 into an Excel document doesn’t mean you’re going to sell 4,000 widgets.
We have a few problems:
Many businesses shouldn’t have been started in the first place. That’s why many small businesses fail in the first place. They’re just not viable.
But they start the business anyway, and then they …
- Overestimate the potential success of their business and underestimate the amount of marketing and sales work required to sell their widgets.
- And then they don’t have a handle on the accounting side of the business, profitability, gross margin, and cash flow.
Manage your cash flow. If you do, there’s no reason that profitability shouldn’t last or that you should forgo today’s profit into perpetuity.
I know, it seems so obvious, but lack of cash is the #1 reason businesses fail.
Good luck, and hopefully the above helps explain why small businesses fail, and what you can do to not become part of that statistic.
Here’s one of the first articles I wrote: My Journey Post Business Sale as I Sail Into a New Harbour.
Are you a younger entrepreneur? Here’s another interesting article I wrote:
My goal is to help entrepreneurs scale their businesses, improve profitability, and then, use those profits to create massive wealth. Subscribe to my blog to receive my latest thought on scaling your business and creating wealth.
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