Marlon has been a long time blog writer. He has contributed content to many sites and is also active in SEO and SMM work.
Running a small business requires you to have guts of steel and the wits of a predator. According to the U.S. Chamber of Commerce data, about 80% of companies with fewer than 500 employees are able to survive their first year in the business, but by year 2, 10% of that figure will be slashed off and by the fifth year of their business operation, only 50% will remain in business.
Fortunately, these sobering statistics don’t keep Americans from reaching for their entrepreneurial dreams. In fact, a total of 1,700,000 small businesses were registered and started operating in 2020 in the United States (in 2019 there were 30.7 million small business companies operating in the U.S. and by 2020 it rose to 31.7 million).
About 47% of those small-business owners who were forced to close up shop said that the main cause of their fall was due to lack of finances to keep the business running. Simply put, the cash flow was not working in their favor as their profits were steadily dropping year after year and there wasn’t enough money to pay their workers or cover other expenses. In this article, we will discuss the 10 most challenging financial problems that small businesses commonly encounter and how to come up with a strategy to win against them.
Top 10 Financial Challenges for Small Businesses
Small business struggle to stay afloat in the industry that they operate in and just like any other business establishments, most of their troubles begin and end with money to run their business. Here are 10 of the most common financial challenges that small businesses gripe with and tips on how you can keep your company solvent, profitable and productive.
- Limited or Inconsistent Cash Flow
- Not Using a Budget
- No Preparation for Unforeseen Expenses
- Not Raising Enough Capital
- Too Much Debt
- Neglecting Necessary Reporting
- Poor Tax Compliance
- Not Paying Bills on Time
- Mixing Business and Personal Finances
- Poor Marketing Tactics
Limited or Inconsistent Cash Flow
Managing cash flow for the business is the biggest problem that most companies face with. From the simple task of effective invoicing so there’ll be enough income to pay for the monthly bills (electricity, water, gas, internet, etc.) to segregating money from your profits to accumulate cash in order to invest in growth and expansion, liquidity is an ongoing issue.
The first thing you need to learn about cash flow is how to balance accounts payable and accounts receivable. When you are able to maximize the cash flow by ensuring there’s more income than cash expenditures, you should be able to secure capital to keep the lights on.
Beyond these basic understanding of cash flow, companies ought to develop cash flow forecasts based on their performance history and current market conditions. In order to develop a realistic financial plan, you must always consider contingencies such as industry changes, economic downturns, and customer shifts. And don’t forget to use “what if?” scenarios too! It pays to be 2 steps ahead of everyone else and simply just hoping for the best isn’t going to cut it, you’d have to be prepared for the worst also. So it would be to your benefit to anticipate scenarios based on current market trends and the political climate, as these have the biggest impact on your business and they will determine the success or failure of your small business. Just look at how the pandemic caught most small businesses off-guard.
If your company offers credit terms to your customers, then here are some ways to improve cash flow;
- Establishing clear payment terms
- Invoicing effectively
- Offering discounts for early payment
- Create conditions to allow customers to pay you easily
Combined, these strategies will maximize liquidity.
Not Using a Budget
Not having a business plan while running a business is a recipe for disaster. Basically, you can’t just sit in your office and hope that there will be enough money in the bank to pay the bills at the end of each month. You’ve just set yourself up to have a staggering debt and other financial responsibilities that will, sooner or later, break your back.
What you need to do is to also include a budget plan in your business plan. Doing this will allow you to navigate the financial pathways of your business, it’ll be useful in analyzing expenditures and it also gives you the ability to make quick yet smart decisions to avoid any risky and disastrous ventures whenever you need to.
Once you’ve created a budget plan, then keep it updated to match the current circumstances that your business is dealing with. Use it as a compass to make good business decisions. You have to actively use your budget plan and not set it aside thinking that you don’t need it right now, because you do. In fact, you’ll always need it.
Your company should have these 5 elements in its budget plan:
- Fixed costs
- Variable costs
- One-time costs
- A cash flow statement
- Profits (what’s left after all of the above are factored in)
It’s also a good idea to have a separate bank account where you can save money for emergency use.
No Preparation for Unforeseen Expenses
Unexpected expenditures can cripple and even kill small businesses. If you can recall the elementary school story with a moral lesson about the ants and the grasshopper, then you’re pretty much in the same situation. Having a dedicated bank account to save up for the “rainy day” makes all the difference between getting through tough times and throwing in the towel. You can also use these financial reserves to grow your business when the time is right.
In times when you make good profits, set aside some of those profits in this reserved bank account and let it grow over time. You can also ask your bank to automatically transfer money from your business checking account to its savings account every month to skip all the hassles of manual transfers. This way you can easily access funds to cover for any emergency that your business might face in the foreseeable future.
The most obvious benefit of the rainy day fund is that it aids your business by avoiding the need to acquire debt. A low debt-to-profit ratio is very good for any business!
Not Raising Enough Capital
In the last 5 years 1 out of 5 business owners was denied the business loan that they’ve applied for, according to Nav’s Small Business American Dream Gap Report, and about 82% of the respondents (all who were business owners) said that they don’t know how to how to quantify the credit scores of their companies. The research also revealed that business owners who knew how to quantify their business credit scores had a 41% chance of getting their loan approved.
Below are the 5 ways you can acquire to get funding for your business:
- Venture Funding - for startups that have a great potential to grow into a corporation.
- Private Equity - for companies who are willing to exchange a portion of their company’s shares for cash.
- SBA-backed Loans - for businesses who need small, short-term loans to supplant their company’s financial needs.
- Bank Loans without Government Support - the bank will require you to provide good collateral and stable, growing revenue. In the case of small businesses, the bank may require you to provide your personal credit score (your house may also be part of the collateral).
- Friends and Family and Personal Savings - according to the Bureau of Labor Statistics, more than 50% of small businesses owners go for this option as it does not involve too much financial risks compared to loans.
A lack of working capital can be a real problem for most companies no matter what size, but it can be life-threatening to small businesses that don’t have a lot of financial options. While having cash readily available to take care of the bills (with some extra for other minor expenses) is good, not having any capital can prevent a small business from hiring people, do business expansion and seek out new opportunities.
If you want to improve your chances of getting a loan, get investors to notice your business, or getting working capital to finance your business, then follow the steps below:
- Create a good business plan, write it down, streamline it for everyone to understand it clearly, and if possible, have a pitch for it ready as well.
- Understand how your business credit score works and if necessary, improve it.
- Make certain that your income and expenses flow, profit & loss (P&L) statements, and balance sheet are up to date, accessible and auditable.
You can handily create the necessary reports mentioned above when you have an automated financial management platform setup and prepare them on time whenever any interested investors or bankers who are willing to lend you money requires them from you.
Too Much Debt
Business owners are typically risk-takers, so it’s not unusual to see them acquire debt to start their businesses – in fact, they’re actually very proud of letting the world know that they’ve “bootstrap” their way to success. However, too much debt can be detrimental to the sustainability of a business. It doesn’t matter how they got stuck neck-deep in the debt that they’re currently in, what’s important is that they’ll need to take care of those debt soon or face extinction. To put this into light, let’s take the company’s positive cash flow as an example, and it can take some time before the firm can sit and kick back on this monetary incentive, meanwhile it’s going to have to take care of paying its employees, suppliers and overhead pending payments.
You can follow these 5 steps in order to reduce your debt and be able to amass financial resources to get your business back on track:
- Look for areas in your business where you can cut down on spending - Perhaps you could liquidate some of your assets that’s costing you money, but are not generating any income. It could be an unused office space that you can sublease or excess equipment that will add more money to your bank account. Although it may seem counterproductive to slash down your workforce, it’s a necessary decision to keep your business running.
- Use runway extenders - Listen to your customers and find ways to boost your exposure and/or improve your business model, and your revenue will also increase. Offer rebates to customers who pay you quicker and ask your suppliers if they can give you discounts and/or deferred payments (they often do).
- Consider creative financing options - Use sites like angel investors, crowdfunding, accelerators and others to raise capital for your business. A loan isn’t your only financing option.
- Contact every creditor and advise them of your predicament - Don’t leave your lenders out in the dark about your current financial situation, as it can make things worse. You can ask your lenders to lower interest rates, increase your credit line or restructure your repayment options, as all parties involved would love to find a solution to this problem.
- Merge all payments for your business loans in order to reduce monthly costs, plus it won’t affect your credit score negatively which is a win-win situation for you - The SBA offers a business debt consolidation loan, where you can get loans for various purposes from a single creditor rather than applying for them from different lenders – you may even get a lower interest rate for it.
Neglecting Necessary Reporting
By simply hiring a bookkeeper to get your financial books in order can help solve a lot of problems. Properly recording all financial transactions such as sales, expenses and earnings will help track down your business’ cash flow. Although private companies are not required by law to report financial data, poor record keeping can cause unwanted problems in the future that might even grow out of control. The federal government can fine you, charge interests, or even prosecute you for misstating revenue on tax forms and making improper deductions.
Filing inaccurate reports or not reporting financial data for public companies can result in financial and time losses that can take a toll on the business.
Your local, state and federal government will want accurate reporting, especially when it comes to filing income tax. Failure to do so – and if the reports are not filed on time – may cost you expensive fines plus other legal penalties, which is basically a headache.
There will definitely be some longterm effects for not recording transactions accurately, for example, they can hurt your monthly cash flow and may also impact other financial reports. You’ll also be in big trouble with the auditors and it will be extremely difficult to explain how you got to this situation. Not only will you face federal litigation but your investors might pull out too!
Business owners use different methods to create reports at their own discretion. While some depend on data retrieved from spreadsheets and receipts, others use automated systems to achieve the same goal. For business owners who want more than automated, accurate financial statements, they should have their own dedicated ERP (enterprise resource planning) system. The benefits of having a modern financial reporting solution includes real-time financial analysis and modeling on every aspect of your business, which helps you improve your overall business performance and make better decisions in the future.
Poor Tax Compliance
It’s already a demanding task managing your business’ cash flow; don’t make things more complicated by overpaying the IRS. Yet records indicate that as much as 85% of small businesses accidentally pay more than what their federal income taxes require annually. On the other hand, a small portion of them underpay and are slapped with hundreds of thousands of dollars’ worth of fines and even some ugly lawsuits. You will waste time, energy and financial resources in managing both situations, so have an eagle eye in complying with the IRS when it comes to taxes.
One of the most pressing issues that businesses cope with when it comes to federal taxes is actually not paying it to the IRS, but rather the cost of compliance. Unfortunately for small businesses they are levied a heavier burden than their larger counterparts. The IRS said that companies with less than a million dollars in revenue shoulder almost two-thirds of business compliance costs.
Not Paying Bills on Time
If you put yourself in their shoes (suppliers, landlords and utilities), then you would demand on time and undelayed payments too! True, suppliers, landlords and utilities do, in fact, overlook occasional late payments to keep a good relationship with their business partners; however, doing it regularly will cause your trade partners to lose their trust in you and this can hurt your business in a big way. Broken trust between the company and the supplier, no longer having access to much needed services and consistently running late on your debt repayments can have a negative impact on your company’s financial health.
According to PayStream Advisors, about 55% of companies still handle their accounts payable (AP) processes. Manually doing Aps is time consuming and is susceptible to fraud and data-entry errors. Automating your AP system saves a significant amount of time and money, not to mention reducing data-entry errors and prevents fraud by not allowing people to corrupt the system. These automation features for the company’s accounts payable automation software will benefit them much and will help prolong the company’s life.
The staff of your company’s finance department will benefit the most with the accounts payable automation software, as it helps reduce the number of manual tasks for them to perform. For instance, businesses can use an automated system to submit invoices, manage the invoice approval process and send payments to vendors, instead of manually managing vendor invoices and recurring expenses.
Mixing Business and Personal Finances
Standard business etiquette says that you, as a business owner, should be prudent enough to understand that personal and business funds should be kept separate. According to a Clutch survey, about more than 25% of small businesses don’t even have a separate business bank account, and 23% of companies have stated that mixing business and personal finances has hampered their growth and prosperity.
There are several disadvantages to this risky practice of commingling business and personal funds. First is that it makes it difficult to monitor cash flow and second, it can damage the company’s value over time that may force the business owner to either shut down his business or sell it to another company and turn it into a merger. When the company will be audited – whether it’s an internal audit or from the government – they’ll tag this as a big red flag that is detrimental to the company’s survival.
You must prioritize solving this problem early on by opening a business account and use it to handle all company-related cash flows (both inflows and outflows) – including your own salary, which should be a fixed amount instead of just a random amount that you take out of your profits each month. Ask your bank if they offer a business credit card and apply for that, so you can use that to manage company expenses, instead of using your personal credit card. This will help keep all business-related items organized and easily accessible.
Finally, growth, including of your bank account, requires soliciting your value proposition—a perpetual challenge for small-business owners.
Poor Marketing Tactics
If your business is not continuously getting new customers, then you’re giving them up to your competitors which is bad for business. And while some small businesses have no problem catering to a fixed customer base to get by, other companies that aims to grow a significant presence in the world must work hard to get new customers regularly in order to achieve their goals.
A carefully crafted plan is needed if business owners are to acquire these clients, one which involves marketing strategies that attract, engage and retain customers. For companies that get this right gets the chance to shine bright.
Some companies do their own marketing in house, while others outsource it to third parties – those that do are willing to pay millions of dollars to get their desired results. But even if you’re working on a small budget you can still make people notice you and buy your product or service. There are resources available online that you can use for your own “guerilla tactics” to outsmart your competitors. Even finance leads can help with social marketing efforts in some surprising ways.
Companies will always face financial challenges no matter what situation they are in; however, it gets a bit more difficult for smaller businesses to handle them and survive the first 5 years in business. You can use the impeccable advice from this article and avoid the common issues that plague small businesses, as you strive to make your company a success.