Three rules small businesses should follow to avoid financial trouble
With registered company insolvencies the highest they have been for a decade, and 50% of new businesses failing within three years, many SMEs face financial trouble; to the point of having to fold. This usually comes down to finances. Many small business owners don't have any accounting qualifications, may never have seen a cash flow statement before, or understand the nuances in respect of tax and VAT. Michael Steed, President of AAT (Association of Accounting Technicians), shares the ‘danger’ signs small businesses need to look out for which indicate they may be in difficulty, and what they can do if they find themselves in financial trouble.
Small businesses are at particular risk of failing in their first three years; in fact, around 50% succumb to this. Usually, the reason a small business folds is down to finances. It may sound surprising, but cash is more important than profit, when it comes to a business surviving or not. Northern Rock is a good example; when it collapsed, it had been profitable, but it had run out of cash. Understanding that profit is not the same as cash, is incredibly important.
Seeing your business fold, having poured time, energy, money, and many late nights into it, can feel like a very lonely position to be in. However, the road of a business owner doesn’t need to be trodden alone. As accountants, who know all too well the influence that finances have on a business’ ability to survive, we want to walk alongside small business owners and help alert them when we can see financial trouble coming.
The fact is, business owners usually haven’t got accounting qualifications, often can’t interpret a Profit and Loss account or balance sheet and may have never seen a cash flow statement before. Therefore, they can’t necessarily spot the warning signs of financial trouble like an accountant can. The sad reality is that some of the small businesses that fold would have been salvageable, if only they had someone who had spotted the signs of trouble and taken action early on.
Rule number one is ‘knowing what to look out for’. Think of it like a car; if a warning light comes on, you don’t sit and wait for the problem to materialise – you get it fixed at the garage.
The two most common signs your business is heading for financial trouble are: you can’t afford to pay yourself anymore and you’re borrowing money in order to keep operating.
Sacrificing your own salary, or drawings, to paper over the cracks can sometimes work, as long as it’s just a short-term solution. However, if the business isn’t generating enough cash long-term to enable you to take a salary, or drawings, or you’re borrowing money to keep it afloat, it isn’t sustainable. You can’t survive forever without a personal wage and borrowing cash just compounds the problem. You’re keeping your business afloat with false money; money that isn’t yours.
Rule number two is ‘stress test the business with someone who understands numbers before launching’. Accountants should play a far bigger role in a small business than just being the person that fills out your tax return for you. Experienced accountants, who have a broad understanding of how businesses work, can be business advisers as well. They can look at your business like a Rubik’s cube, from every angle. Work with an accountant to go over your business plan, pricing, cash-flow forecasts and growth strategy before you start.
Rule number 3 is ‘communicate with creditors and chase debtors’. If you can’t pay an invoice on time, don’t shy away from talking to creditors (people you owe money to). Agreeing new payment terms or setting up a payment plan is all entirely possible and could give you the breathing space you need. Equally, you need to chase debtors (people who owe you money). Cash problems in small businesses are often driven by not getting paid on time, so set aside time each month to chase up invoices and make sure you have received money owed to you, on time.
If you do find yourself in financial trouble, there are things that can be done. First, seek advice as early as possible. There will be various options available to you such as reorganising the debt, arranging a new loan or securing funding. Cost cutting may need to be done, whether that’s reducing staff headcount, moving office space or changing operating hours to reduce overheads. Additionally, you may need to have conversations with HMRC if you know you will be unable to pay your VAT or tax on time.
As I’ve said, prevention is better than cure. If you don’t maintain your car properly, it will eventually break down. It’s exactly the same with a business. As early as you can, engage a qualified and licensed accountant; one you know you can trust. Having experts who know what to look out for, and can steer you away from any impending dangers, will be instrumental in your business’ survival.
To access our free Small Business Survival eBook please visit informi.co.uk/10steps
