Over the years I have seen many small businesses fail – mostly sole proprietorships. As the name implies a sole proprietorship is a business owned by one person who runs it mostly by themselves.
They don’t fail suddenly; It usually happens over a period of time after entering what I call the “Cycle of Death”. Here is how that cycle progresses:
- The owner needs to pay his “cost of sales” until money starts rolling in. Cost of sales includes raw materials, supplies, labor and other items associated with doing a particular job.
- He usually uses a credit card or a line of credit to pay for the cost of sales and sometimes takes money up front from the customer.
- As money comes in from the customer, he finds he needs it for basic necessities at home and he needs to buy more materials for future jobs.
- He forgets to pay off the credit card and figures he’ll get caught up when cash flow improves.
- His balance on his credit card mounts and he finds that cash flow is just enough to pay the “minimum monthly payments”.
- Then as the end of the year approaches, he realizes he never socked away any taxes!
- He spent just about everything he brought in, plus maxed out his credit. Now he is facing a tax bill. He didn’t realize that at least 30% of everything he nets belongs to the government!
- In an effort to get ahead, he hustles to get new jobs. He takes more money up front and forgets that more money means more taxes and he again doesn’t plan for that.
- Death of the business soon follows and the owner is faced with personal liability and a big tax bill.
- Bankruptcy is often the next step.
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