Analysis: 12 reasons small businesses fail
Just like there are 50 ways to leave your lover, there’s many reasons people choose to walk away from their kombucha businesses. But, beyond the story of each failed brand, some underlying trends are clear.
Following my report on the failure rate of kombucha companies in the UK and California, it’s interesting to speculate about the reasons small firms shut up shop.
It’s clear that macro trends (“kombucha is too expensive/sour/strange for the average person,” “there’s been a general economic downturn,” “because of COVID-19”) are just one piece the puzzle. If, in fact, half of all companies fail, the other half working in the same overall environment make a success of things.
So which problems cause some to fall by the wayside?
The business analytics company CB Insights lists a dozen reasons why:
- Profits aren’t cash; they’re accounting. And accounting is a lot more creative than you think. You can’t pay bills with profits. Actually profits can lull you to sleep. If you pay your bills and your customers don’t, it’s suddenly business hell. You can make profits without making any money.
- Cash flow isn’t intuitive. Don’t try to do it in your head. Making the sales doesn’t necessarily mean you have the money. Incurring the expense doesn’t necessarily mean you paid for it already. Inventory is usually bought and paid for and then stored until it becomes cost of sales.
- Growth sucks up cash. It’s paradoxical. The best of times can be hiding the worst of times. One of the toughest years my company had was when we doubled sales and almost went broke. We were building things two months in advance and getting the money from sales six months late. Add growth to that and it can be like a Trojan horse, hiding a problem inside a solution. Yes, of course you want to grow; we all want to grow our businesses. But be careful because growth costs cash. It’s a matter of working capital. The faster you grow, the more financing you need.
- Business-to-business sales suck up your cash. The simple view is that sales mean money, but when you’re a business selling to another business, it’s rarely that simple. You deliver the goods or services along with an invoice, and they pay the invoice later. Usually that’s months later. And businesses are good customers, so you can’t just throw them into collections because then they’ll never buy from you again. So you wait. When you sell something to a distributor that sells it to a retailer, you typically get the money four or five months later if you’re lucky.
- Inventory sucks up cash. You have to buy your product or build it before you can sell it. Even if you put the product on your shelves and wait to sell it, your suppliers expect to get paid. Here’s a simple rule of thumb: Every dollar you have in inventory is a dollar you don’t have in cash.
- Working capital is your best survival skill. Technically, working capital is an accounting term for what’s left over when you subtract current liabilities from current assets. Practically, it’s money in the bank that you use to pay your running costs and expenses and buy inventory while waiting to get paid by your business customers.
- “Receivables” is a four-letter word. (See rule 4.) The money your customers owe you is called “accounts receivable.” Here’s a shortcut to cash planning: Every dollar in accounts receivable is a dollar less cash.
- Bankers hate surprises. Plan ahead. You get no extra points for spontaneity when dealing with banks. If you see a growth spurt coming, a new product opportunity or a problem with customers paying, the sooner you get to the bank armed with charts and a realistic plan, the better off you’ll be.
- Watch these three vital metrics: “Collection days” is a measure of how long you wait to get paid. “Inventory turnover” is a measure of how long your inventory sits on your working capital and clogs your cash flow. “Payment days” is how long you wait to pay your vendors. Always monitor these three vital signs of cash flow. Project them 12 months ahead and compare your plan to what actually happens.
If you’re the exception rather than the rule, hooray for you. If all your customers pay you immediately when they buy from you, and you don’t buy things before you sell them, then relax. But if you sell to businesses, keep in mind that they usually don’t pay immediately.
TIG Brands advises the best way to get a handle on the numbers:
Profitability is built on strong unit economics. From day one, you must get your cost of goods and selling price to work for you and not against you. A common mistake is to target a specific SRP and hope economies of scale afford you the long-term margin you need. This rarely happens; even when it does, it often takes too long. You need to give yourself a chance at profitability from the start. This might limit where and how you sell, but that is an acceptable trade-off. Search for the outlets, channels, and geographies that allow you to charge what you need to return a contribution margin that gives you a path toward a positive bottom line.
This approach takes discipline. It often means saying “no” to opportunities that you desperately want to say “yes” to. You may need to walk away from the opportunity to launch in a large-scale retailer or to invest heavily in customer acquisition to drive revenue on your website. Your growth rate might be slower than what you see from others, and what you are being told is indicative of a “hot” brand. But discipline ensures you get profitable faster, and temptation is the road to ruin.
Explaining why business-to-business sales is a challenge. TIG employs what they call “locked box analysis“:
When you say “yes” to a growth opportunity, you make a cash commitment for inventory, receivables, free-fills, trade, merchandising, and more. You’re also pledging your team’s bandwidth to support the new initiative. You place that cash and available bandwidth in a box, sealing it and putting it on a shelf that is out of reach. You can’t use what is in that box to support any other opportunities or business needs. Understanding this reality leads to better decision-making.
Let me illustrate its use. A brand has an opportunity to go into 500 new stores. What is it going to require? They are going to have to do a production run. The co-man requires a 50% deposit to schedule a run. We’ll call that $100k, and it goes into the box. They are six months away from being on the shelf. That money is no longer available to the business. As they get closer to launch, they produce and pay the balance for the run, another $100k into the box. They finally get the PO from the distributor but know most will go towards the free-fill. They engage a merchandising team for $80k, which also goes into the box. They ask their social media and sales teams to be laser-focused to ensure a successful outcome. That available bandwidth all goes into the box.
Quick math shows us that they have $280k locked in a box that they can’t access for any other business need. They have also placed a significant amount of the productivity of their social media and sales teams in that same box.
As a business leader, you need to recognize what you are putting into the box with each new opportunity you consider. Then you need to ask the tough questions. In the above case, how would locking that $280k away for a significant amount of time impact the other important things that need to be done to support the business? Would consuming that much of your team’s bandwidth affect other critical initiatives?
If only there was a book that startups could read as a guide to the practices successful companies adopt, and warnings about the mistakes to avoid on the way. These lessons could generate new ideas, new possibilities for you, in your business, that you might be able to take in, digest, and adopt to your situation.
There is such a book. I’ll review it in my next post. Stay tuned.