Most people think startups and small businesses fail because of things like poor marketing, or not being able to properly establish product-market fit.
And while those things certainly play a role in the company’s success or failure, they are not the primary reason why companies go under. In fact, hiring issues, not being able to find investors, having the wrong people in the wrong roles, co-founder disputes, even losing customers to the competition, all come second to cash management.
Cash is what keeps the lights on.
There are 6 reasons why companies end up mismanaging their cash—and none of them are because managing cash is a particularly difficult thing to do. Cash management is one of the fundamental parts of running a profitable business, and now more than ever, it is a pitfall small businesses can easily avoid.
1. Most companies do not have a firm understanding of “cash flow.”
In the simplest sense, cash flow is defined as, “The total amount of money being transferred into and out of a business.”
If you are doing $100,000 in revenue each month, but your expenses are also $100,000 each month, then you are essentially running a business that’s living paycheck to paycheck. Anything that comes in immediately goes back out—to pay for the office space, your employees’ time, etc. On the other hand, if you are doing $100,000 in revenue each month, but your expenses are $50,000 each month, you are in a much healthier position—not just from a profitability standpoint, but from a cash flow standpoint as well.
The best way to understand your company’s cash flow is by implementing financial forecasting. If you use Salesforce, our tool can easily integrate into your system to make it easy for you to understand whether you are living “paycheck to paycheck” or you are in a healthy position.
2. Most companies don’t begin with enough cash-on-hand.
Remember when you were 10 years old, and you set up your first lemonade stand?
One of the lessons you probably learned right away was that you needed to have a few extra bills in your plastic cash register. Either someone was going to hand you a bill too big, and you needed to have some “cash-on-hand” to break their $20, or you were going to have to run to the store down the street to buy new cups or more lemonade.
Well, these same entrepreneurial lessons remain true for even the largest of businesses. If cash flow is the gap (and subsequent risk) between money coming in and money going out, then cash-on-hand is how much money (relatively speaking) you have ready to be deployed at any moment: for hiring, for firing, for scaling, etc. And most companies simply don’t start with enough.
3. Most companies miscalculate what they actually need in order to turn a profit.
Not every business is profitable on day one.
In many cases, a business owner must incur expenses in order to even open shop. A restaurant, for example, needs a physical location, food inspection, trained staff, menus, etc., all before doors can even open. The business owner then takes on the risk of incurring these expenses with the assumption that once they’re open for business, they will make back their investment (and then some) after a certain period of time.
Unfortunately, these projections are oftentimes wrong.
This is another scenario where financial forecasting tools can be tremendously helpful. The more insight you have into where your expenses are coming from, the better you will be able to understand when profitability is realistic.
4. Most companies do not capture their true costs in their pricing models.
The price of an item or service is not just a reflection of that one item or service.
Instead, pricing should be a reflection of all the true costs associated: cost of insurance, cost of overhead, cost of shipping and handling, cost of managing, etc. If you are a candle shop, and you are selling candles, item prices also need to take into account all of the other costs the business incurs to sell those items in the first place.
And yet, many companies do not take the time to consider their true cost of doing business—and pricing accordingly.
5. Most companies make decisions based on best-case scenarios, as opposed to conservative projections.
Your company’s best month should be a moment of celebration and not the assumed average.
If your business does 2x revenue this month as it did last month, this does not mean your company’s new average revenue has now doubled. Yes, you have a new data point to examine, and you may be trending up and to the right, but many businesses get themselves into dangerous territory when they get too optimistic about the future.
Instead, it’s better to keep financial projections conservative, so that you end up with more than you originally thought—opposed to dramatically less.
6. Most companies don’t know when to ask for help.
The reality is, cash management is a very solvable issue within a business.
However, it requires two things: commitment on the founder’s part to learn, and a willingness to admit when something isn’t working.
In most cases, small businesses don’t fail from a lack of effort, or because the people involved weren’t capable. These businesses fail because no one was willing to come forward and ask for help—either from a lack of knowledge as to what questions to ask in the first place, or embarrassment. But it’s important to remember that cash management is a skill just like any other, and it requires time, energy, patience, and persistence in order to get it right.