Avoiding the #1 Reason Why Small Businesses Fail

Starting a new business is exciting, but it's no secret that a high percentage of small businesses fail within the first two years. One of the most common reasons is poor cash flow management. Without a clear understanding of realistic income expectations versus expenses, many entrepreneurs find themselves unable to cover costs or invest in growth. But don’t worry—there are steps you can take and people available to help you.

What should you do to avoid cash flow issues before they happen?

While this is not an all-inclusive list, here are 6 tips to consider.  

1. Start with a detailed business plan

Include a financial forecast that outlines your expected income, expenses, breakeven, and profit. Of course, this is much easier said than done. How do you determine these numbers before you’ve even opened your doors?!

Research your market:

Study your industry and competitors to understand their pricing, customer demand, and revenue trends. Consider your service area and who your customers will be.

Identify and list all your costs:

• Fixed costs are expenses that remain constant regardless of production (IE: rent, utilities, salaries, insurance)
• Variable costs are those that vary with production, like materials, packaging, and labor directly tied to making the product.
• Hidden costs are those expenses many forget to include in the mix, they include taxes, payment processing fees, and material/packaging waste. It’s recommended to add 5-15% more to your variable costs to account for waste.
• Start-up costs need to be accounted for, they include licenses, equipment, and the initial inventory of materials.

Consult professionals:

An accountant can help ensure you’re accounting for everything. (Don’t forget to add them (their fee) into the cost buckets above.)

Tip: Seek advice and assistance through organizations like SCORE (Service Corps of Retired Executives). It provides free business counseling, training and mentorships. Or find a Small Business Development Center (SBDC); there are many (generally on campuses) throughout the state of Wisconsin. Both organizations can assist in the drafting of your business plan and projections.

Other professionals to consider include a business attorney. An attorney can help you with patents, drafting contracts, establishing operating agreements or by-laws if partners are involved. They could also help you avoid HR pitfalls and other liability concerns. Another professional would be a business insurance agent. They can provide you with fraud protection and coverage for the assets you’ve acquired. A sub-contracted human resources representative or company might be a worthwhile consideration, and a marketing expert to assist you with a prominent online presence and social media strategy.

Determine your selling price per unit.

While you shouldn’t base your business plan solely on what the competition is doing, it’s important to consider market pricing. If your competitors are selling a similar product at a price lower than your total costs, it might be a strong indicator to reconsider pursuing this business venture.

Define your sales goals:

How many products/units do you think you can sell annually? (Or, if you are selling a service, how many service hours do you think you’ll be able to charge for during the year?) Be brutally honest and realistic. (We can’t stress that word enough, ‘realistic’.) Ask yourself: ‘Why are people going to buy your product or service over what they are already familiar with?’ Sales are typically low the first year and sometimes into the second year too. Ensure your prices are competitive but still profitable. And be sure to consider seasonal trends and your marketing efforts.

• Be conservative. You may not breakeven the first year….  It’s better to underestimate and outperform than to overestimate and fall short. Most people will estimate their sales on a monthly basis and then add them all up for a yearly estimate.

Calculate the breakeven point:

The result of this equation will tell you the number of units you need to sell to cover all costs.

_______________Fixed Costs______________
Selling Price per Unit – Variable Cost per Unit    =  Breakeven Point (units)

Example:  
Fixed costs = $10,000      Variable cost/unit = $5    Selling price/unit = $15

                                             Breakeven Point =   $10,000   = 1,000 units
                                                                                          15-5     

You need to sell 1,000 units to break even. Beyond that, every unit (or service hour) sold contributes to profit.

Should an entrepreneur include their compensation into the breakeven point analysis?

Yes, if they plan to pay themselves, they should add it to fixed costs.

Adding it reflects the true cost of running the business and supports sustainability (future growth). By including it, it helps ensure the business can support both its operations and the entrepreneur’s livelihood.

________Fixed Costs_+ Desired Compensation____
   Selling Price per Unit – Variable Cost per Unit            =  Breakeven Point (units)

Now compare what you need to break even and what you realistically think you can sell. What’s the difference between the two? Is it concerning? Will the number of units predicted to sell in year two or three surpass the breakeven point?

2. Create a Realistic Budget

Stick to a budget that accounts for fixed and variable costs. Prioritize essential expenses and set aside a cushion for emergencies.

Tip:  Again, working with an accountant or a nonprofit organization that provides free business mentoring to small businesses could be extremely helpful in this realm.

Online financial templates can assist with cash flow forecasting and budgeting. Accounting software (like QuickBooks, Wave, or Xero) can simplify tracking and forecasting.

3. Monitor Cash Flow Regularly

Use accounting software or hire a professional to track your finances in real-time. Regular reviews help you spot problems before they escalate.

From a cash management perspective, Prevail Bank offers customers two versions of Business Resource Manager (BRM), basic and premium. It maximizes efficiencies pertaining to online bill pay, payroll management, electronic funds transfer, remote deposit, among other functionalities for small businesses, including a fraud prevention system to protect against altered, forged, and counterfeit checks.

4. Secure Adequate Funding

Don’t underestimate the capital needed to sustain your business. Explore options like small business loans, grants, or investors to ensure you’re financially prepared.

Tip:  Prevail Bank’s Commercial Lending Officers can lend a hand here. Our Officers have years of experience.

5. Build Strong Relationships

Maintain good communication with suppliers, customers, and your banker. Negotiating payment terms and encouraging timely payments can stabilize your cash flow.

6. Plan for Seasonal Fluctuations

Anticipate periods of high and low revenue. Be able to adjust your spending accordingly and have a back-up plan if your revenue projections or expenses aren’t what you predicted.

Conclusion

Financial challenges are common. Common signs of cash flow issues include struggling to pay bills on time, relying heavily on credit for daily operations, and inconsistent revenue streams with no backup plan. But with careful planning, regular monitoring, and proactive adjustments, your small business can thrive.

Build strong relationships with your accountant, business lawyer, business insurance agent, and banker. This is the team that supports your business.

Remember, the foundation of success is preparation—and you’ve got this!

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