According to the Small Business Administration, only about 50 percent of small businesses survive for a five year period. And, just one third are able to make it to the 10-year mark. While these statistics may not seem particularly encouraging, by identifying some of the common root causes of financial distress, you can take steps to steer things in the right direction before it’s too late.
Here are the five biggest financial warning signs your business should be aware of:
Receivables Keep Climbing Month After Month
Many businesses offer credit terms to some of their customers. This is known as your accounts receivable (or AR for short) and represents the balance of money owed to a firm for goods delivered or services delivered. Accounts receivable is an asset on the balance sheet.
Related: 3 Financial Statements Every Business Owner Should Understand
Unfortunately, not all customers pay on time and if your receivables are growing too high it can signal trouble for your cash flow.
- Create an accounts receivable aging report – this is a powerful tool to help you pinpoint how much is due from each customer and which invoices need the most urgent attention.
- Automate your invoices – the faster you can get your invoices out to your customers, the faster you are likely to get paid.
- Shorten payment terms – you don’t always have to offer net 30 payment terms to your customers. Shorter terms will often encourage laggards to be more prompt with settling their invoices.
Your Business is Heavily Dependent on Nonoperating Revenue
Your small business revenue may be comprised of operating revenue and nonoperating revenue. Operating revenue refers to the revenue you receive from your business’ main activities. For example, if you own a bakery, your operating revenues would come from selling pies, breads, and other similar goods. If you own a massage spa, your revenues would come from the sale of your services such as facials.
On the other hand, as the name suggests, nonoperating revenue refers to money earned from activities that are outside of your core operations. Examples include dividends, royalties, interest, and rental income. Nonoperating revenue will appear after operating revenue on the income statement.
Since nonoperating revenue is typically irregular, your business should rely on the money earned from core business operations to cover day-to-day expenses.
Your Inventory Levels Are Rising
Inventory refers to the stock of saleable goods or raw materials that will be used in creating items for sale. Not every business holds inventory but if yours does, then proper inventory management is key.
Successful inventory management is all about striking the right balance between having enough inventory to satisfy customer demand but not so much that your carrying costs spike.
- Calculate and monitor the following key inventory ratios
- Inventory turnover = COGS / Avg. Cost of Inventory on Hand
The result signifies the number of times inventory is sold and restocked in a particular time period (usually one year).
- Days sales in inventory = 365 / Inventory turnover
The result indicates how many days, on average, it takes to sell inventory.
- Inventory turnover = COGS / Avg. Cost of Inventory on Hand
- Compare your company’s metrics to those of similar companies in the industry as a starting point to determine how much inventory you should keep on hand.
Customer Retention Rates Are Consistently Slipping
Did you know that it is between five and 25 times more expensive to acquire a new customer than it is to retain an existing one? Ensuring your existing customers are well-served not only helps you to keep customer acquisition costs low but increasing customer retention by just 5 percent can boost profitability by 25 to 95 percent, according to Harvard Business Review.
- Create a loyalty program for long-standing customers.
- Create a referral program to reward customers for spreading the word about your business.
- Celebrate milestones such as birthdays and customer anniversaries with a special coupon code.
- Surprise your customers with freebies “just because”.
- Create a recurring reminder (e.g. once a month) to send a checking-in email or phone call.
Too many business owners only focus on top line (revenue) growth and ignore margins altogether. Maintaining or improving profit margins gives your business scope to innovate, attract new talent, invest in new technology, and prepare for growth.
Your gross margin is the difference between revenue and cost of goods sold, expressed as a percentage. This is an indicator of your business’ ability to cover the remaining expenses outside of the cost of goods sold. Having a high gross margin generally means that you are in a better position to have a robust operating margin and a healthy bottom line if your operating and other expenses are well managed. The operating margin is calculated by subtracting your overhead expenses from your gross revenue and just like the gross margin it is expressed as a percentage of revenue.
- Managing Cost – There are many areas you can look at in this regard such as securing cheaper office space, outsourcing certain functions, or going paperless. Leave no stone unturned when it comes to reviewing every expense item that your business incurs.
- Review pricing strategy – How well are your products and services priced? Is it time to raise prices or perhaps remove low-margin items from your product or service offering altogether?
Next Steps: Get Professional Help
As a small business owner, you may feel as though you have limited options that are both affordable and effective when it comes to accessing professional advice from a financial expert. However, hiring a virtual CFO, also known as an outsourced CFO, allows you to unlock invaluable financial insights in order to streamline your operations, improve cash flow management and scale your business — at a much more affordable price point than bringing on an in-house CFO.
Contact the RQB team today to see how we can meet your small business financial needs!