SMALL BUSINESS CYCLE OF DEATH

Posted by Tom Martino at 2:13 am 49 Comments Print

Starting a small business is something many of us dream about.  We see it as a way to gain more financial rewards and a promising future.  But without discipline we could end up in a small business cycle of death.

Over the years I have seen a repeated pattern that seems to snag many people who go into business for themselves.  I share it here in the hopes that you may prevent the pattern should you decide to venture into a business of your own.

One of the fundamentals of business is that all sales have associated costs, commonly referred to as the “Cost of Sales”.  A simple example of this is the cost of components if you are in the business of assembling and selling computers … or the cost of paint if you are painting houses.

Many entrepreneurs use credit cards to pay for the Cost of Sales with the idea of paying off the balance when the sale is complete.  However those good intentions are often ignored when cash flow gets tight, which leads to the cycle of death.

Here’s a basic scenario I’ve seen repeated time and time again:

• Joe buys  components to make a big computer server for an important client.
• Since he doesn’t have the cash to buy the components,  he charges $1,500 to his credit card.
• Joe assembles the computer server but is delayed in finalizing the sale and installation due to scheduling conflicts.
• When Joe finally installs it, his big client informs him that he’ll get a check in a few days.
• A few days turns into weeks.
• Meanwhile, Joe charges more components on his credit card to build computers for other customers.
• Since cash flow took longer to establish than anticipated, he finds himself putting off paying some of his bills at home.
• Good news!  Joe finally gets paid for that big computer server.
• Bad news!  He is so far behind in his other debts that he takes all of the money to make payments on them.
• More bad news!  He doesn’t pay the “Cost of Sale” for the computer server.
• Even more bad news!  He doesn’t account for taxes that will be due on the income.
• Better news!  Joe eventually establishes some steady sales generating a modest cash flow. But then realizes he still has a balance on his credit cards, along with finance charges.
• And to make matters worse … he’s at the end of the year and he realizes he owes $6,000 in taxes.
• Joe doesn’t have the money because he spent every dollar he made just to stay afloat.
• Eventually, he realizes he can’t pay his taxes and he can’t pay his credit card balance.
• He also realizes he can’t make any new computers because he can’t use his credit card to buy components.
• Cycle of Death complete:  Joe goes out of business!

NOW LET’S TALK ABOUT PREVENTING THE CYCLE OF DEATH … 

• Joe buys components to make a big computer server for an important client.
• Since he doesn’t have the cash to buy the components,  he charges $1,500 to his credit card.  FIRST MISTAKE!  Don’t start your business without cash reserves.  You need cash to “hold you over” until steady income has been established.  
• Joe assembles the computer server but is delayed in finalizing the sale and installation due to scheduling conflicts.
• When Joe finally installs it, his big client informs him that he’ll get a check in a few days. SECOND MISTAKE!  As a new business do not extend credit to clients.  Insist on payment at the time the sale is completed.  
• A few days turns into weeks.
• Meanwhile, Joe charges more components on his credit card to build computers for other customers.  THIRD MISTAKE!  If you run out of initial cash reserves avoid using credit cards.  Instead ask clients for deposits on the transaction.
• Since cash flow took longer to establish than anticipated, he finds himself putting off paying some of his bills at home.  FOURTH MISTAKE!  In addition to initial cash reserves for  the business, you should also have sufficient savings at home to “hold you over” until income is established.
• Good news!  Joe finally gets paid for that big computer server.
• Bad news!  He is so far behind in his other debts that he takes all of the money to make payments on them.
• More bad news!  He doesn’t pay the “Cost of Sale” for the computer server.
• Even more bad news!  He doesn’t account for taxes that will be due on the income.  FIFTH MISTAKE!  Always make sure taxes remain in the business until paid.  Don’t ever assume all of the revenue is yours!
• Better news!  Joe eventually establishes some steady sales generating a modest cash flow. But then realizes he still has a balance on his credit cards, along with finance charges.
• And to make matters worse … he’s at the end of the year and he realizes he owes $6,000 in taxes.
• Joe doesn’t have the money because he spent every dollar he made just to stay afloat.
• Eventually, he realizes he can’t pay his taxes and he can’t pay his credit card balance.
• He also realizes he can’t make any new computers because he can’t use his credit card to buy components.  TIP!  Always pay “Cost of Sales” on each job as soon as the job is completed and payment is collected.
• Cycle of Death complete:  Joe goes out of business!

You may feel it’s impossible to save enough money to start a business with initial cash reserves and savings at home but they are imperative to increase your chances of survival.  

Treat initial cash reserves and savings at home as integral parts of your business model.

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