In tough economic times, small businesses are often the first to go under, and with the recent financial crisis, many have struggled to survive. While the worst is now well and truly behind us and the operators still standing are breathing a big sigh of relief and looking to the future, those that became victims of the crisis will be picking up the pieces and wondering where it all went wrong. There is a fine line between failure and success; one that small businesses have to tread very carefully. Here we look at the reasons why small businesses fail in the first couple of years of operation, and steps they can take to stop this from happening.
Australia’s most deadliest business myth is that the majority of small businesses will fail in their first year, and the percentage of business failures has been greatly exaggerated over the years. Evidence suggests that first-time operators have roughly a 50/50 chance of survival, and that will largely depend on how they manage the business. The more efficient and savvy they are, the lower the failure rate. According to Australian Bureau of Statistics, an estimated 42 percent of small businesses ‘exited’ between 2003 and 2007. When you look closely at the exits and how they got into that position in the first place, it becomes apparent that they found the challenges of growing a business, employing staff, paying taxes, getting entangled in government red tape and managing money all too hard.
“Failing to plan is planning to fail”
In recent years, the idea of running a business has become somewhat glamorous. In fact, a recent survey commissioned by St George Bank found that around five million Australians are attracted to the idea of starting their own business, with the belief it will offer more flexible working arrangements. However, business owners will be the first to say that the reality is quite different from the fantasy. A lot of blood, sweat and tears go into it, and many just won’t make it. Inexperience and lack of understanding about the industry is often is the first hurdle small business operators face.
According to Rob Wong, CEO of Catalogue Central, many go into business without even knowing the basics of what is involved. “They are not as capable as they think they are going into it,” he says. “It’s important to have knowledge of the industry you are getting into and how your business will fit into that to ensure you are not caught out.”
That’s where planning and goal setting can come in handy, says business coach Pam Usher. Working for one of Australia’s top business coaching firms, Action Coach, Usher has mentored and trained many first-time business operators and one of the first things she tells her subjects is to plan, plan, plan! “One of the main things I find over and over again as a business coach is that companies don’t set out clear goals for themselves and a clear goal for the business,” she says.
Usher considers herself an ‘accountability coach’ and holds her clients to their goals. “There is no room for procrastination in that first year,” she explains. She recommends start-ups write out a thorough and solid business plan in the first instance, with clear goals for a 12-month period, which should then be broken down into 90-day plans. The business plan should not only include the internal goals of the business, but also how the business will position itself within the marketplace.
Business owners can often get so swept up in the moment and are so focused on moving forward, that they forget to take a step back and take stock of how they are going to get to where they want to go. Small business mentor Yesim Nicholson says many business owners will keep all their ideas and plans up in their head and never write them down. “Some people find the idea of writing a business plan daunting when it needn’t be. Your plan should be something that motivates you, inspires you and keeps you on track.”
“If you don’t measure it, you can’t manage it”
Business is a numbers game and many first-time operators often forget this. “All too often, new businesses just watch their bank account, rather than aligning their goals to a set of numbers—financial forecasts—and then to their strategies on a daily basis,” says Usher. Writing a set of financial forecasts goes hand-in-hand with business planning and can be a great way for the business owner to keep up with how the business is progressing, and whether they are on track with their goals.
Having good systems in place can also help to ensure that the business stays on top of its responsibilities. Bob Greenup, a business broker and consultant to SMEs, has seen the challenges new entrants into the business market face on a regular basis, and with more 20 years experience running his own business as well as operating large businesses for others, knows the value of having good systems in place. “Business failures often occur because the business either has little systemisation or the systems are too complex for the business operators to understand,” he explains. “Developing robust systems to control all elements of your business is a crucial element to being on top of the challenges.”
The quality of the systems must also be maintained and kept up-to-date. According to Andrew Needham, a business recovery expert with HLB Mann Judd, many start-ups often make the mistake of assuming that they can just go out and buy a package from the shops that will help them manage one part of their business and then they forget it is there. “Often we see businesses who are in need of an accounting system so they go buy a copy of MYOB off the shelf and then that’s it. But they hardly ever use it or keep it up-to-date,” he says. “They start to fall behind on their GST reporting and it becomes a much bigger issue in relation to cash flow management.”
“Happiness is a positive cash flow”
For small business owners, cash flow is the lifeblood of the business and maintaining a healthy cash flow is as critical to them as breathing. Needham says that the minute a business starts to struggle with cash flow, the red flag immediately goes up. Typically, if a business falls behind on their payments it either means one of two things: they went into the business undercapitalised, or they confused revenue with profit.
Linda Finch, an accountant with Fletcher Tax Accountants is of the opinion that going into a business undercapitalised and then spending like there is no tomorrow is one of the worst mistakes a first-time operator can make. “First year businesses often go out with a ‘spend, spend, spend’ attitude. They neglect to think about how each expenditure is going to benefit their business. Like renovating a house ready for sale, a dollar-for-dollar return is often not achieved.”
The misconception that many first-time operators often make is that if they have enough money to put themselves into the business in the first place, then they will easily be able to maintain and grow that business. Unfortunately this is not always the case, something Michael Dempsey, managing director of Ezidebit and former small business owner, found out the hard way. “They [the business owner] might have gone into the business fully stretched,” he explains. “They had enough money to put themselves in the business, but once the business is up and running they find their debts have started to blow out by 90 days. They are not getting money into the business, so all of a sudden they are stretched for cash and can’t pay their immediate debts.”
Business broker Greenup says inexperienced operators often confuse revenue with profit, particularly in the early stages. He gives the following example: “Say the business owner has $20,000 per week coming into his/her bank account, $2,000 of which might be eventual profit, but he/she spends as though the $20,000 is his/hers. It actually belongs to the suppliers, landlords, utility companies and staff, then he/she gets what is left over.” Greenup says that business owners can often get excited when the first lot of money comes pouring into the business and they act like a kid at Christmas. “If a new business owner has been used to budgeting $1,000 per week wage then suddenly gets $20,000 a week; without any solid systems to know how much is actually theirs to keep, it is like having a free credit card,” he explains. “Then reality catches up with them and the business is on the defensive for months, recovering from the initial euphoria of having substantial early positive cash flow.”
Cash flow can make or break a business and is a crucial element of the business mix that cannot be ignored.
“Business has only two functions – marketing and innovation”
Marketing plays a critical role in any business and, if done incorrectly, can cause permanent damage to the business’ brand and reputation. When the question “why do small businesses fail?” is asked, the first thing that comes to mind is troubles with cash flow. Without money there is no business, right? But marketing can be just as important. It’s one thing to have a product, but if you can’t successfully market that product and convince your customers to buy it, there will be no money to flow into the business.
Any business owner will tell you that customers are the most important part of the marketing mix; a fact to which Wong from Catalogue Central can attest. As the CEO of successful online catalogue business Catalogue Central, Wong has achieved 80 percent year-on-year growth since launching in 2006, simply by listening to his customers. “Know who your customers are and what they want from your service,” he suggests. “At Catalogue Central we simplified things for the customer. They were running around trying to find specials online, searching through a million different websites. We made it easy for them by giving them access to all the information they need in the one place.”
Cat Matson, director of client development for consulting firm Alito, puts it down to the fact that many businesses don’t understand the importance of a strategic approach when it comes to marketing, and therefore often take a ‘hit-and-miss’ approach. “I see many clients who say ‘look, we’ve done all this advertising and it’s not working’, and when I look at their advertising I can see why. It is not strategic or consistent. They haven’t sat down and talked about who they are targeting and why.”
According to Usher from Action Coach, it is important to always be one step ahead of the game and to change up or add value to your offering. “I witnessed two examples of recruitment companies trying to stay relevant during the crisis. One did not diversify its services and as a result had to close down its door. The other saw the economic situation was changing so they diversified. They knew people would be getting rid of their HR managers, so they became the external HR managers as well as the recruitment, and they thrived.”
“Be the captain of your own ship and the master of your destiny”
There are many reasons why small business operators will fail within the first few years; so many, in fact, that it is hard to touch on all of them. However, the most common causes of failure stem from the fact that operators lack the experience or knowledge to run a business and therefore neglect to undertake basic tasks such as writing a business plan and having a good set of financial figures. They have trouble implementing proper business systems and fail to keep them up-to-date, which then impacts their cash flow.
The road to success is never going to be a smooth one, so the key is knowing how to navigate over the bumps.