Sadly, when a business fails, it is often not because it was founded on a bad idea. It’s because it simply runs out of money. Even if the business is profitable, it can still be cash-starved out of business. How does that happen?
Several ways.
If the business is a brand new startup, the entrepreneur at the controls will often underestimate his or her expenses. It might be that s/he misunderstood the labor market and ended up having to pay more than expected for key positions. Or, the cost of raw materials or inventory might have spiked unexpectedly. Or maybe sales just didn’t ramp up as quickly as expected. The bottom line is, too many startups try to get their doors open on a shoestring. If their sales forecasts and expense projections are right on target, they may get away with it. But more often, something is overlooked or something unanticipated occurs, and before the fledgling business knows it, it’s awash in red ink.
The second problem small business owners tend to bring on themselves is trying to grow the business too quickly. In almost every case, growth is expensive. A business may need to add people or inventory or equipment or office space to handle the additional volume. An owner may try to handle growth expenses out of earnings (rather than borrowing from a bank or a private investor), but like his startup counterpart, this owner may fall victim to an overly optimistic sales forecast. When sales don’t explode as planned, we suddenly have some significant extra expenses (people, inventory, equipment or office space) without sufficient new sales to cover those expenses.
The problem in both cases is the natural optimism of the entrepreneur . . . the expectation that everything will work out somehow. The “can do” spirit and “full speed ahead” determination is what makes them unique and successful. But it can also get them in trouble if they don’t correctly anticipate their cash requirements.
The answer, of course, is to keep a cash reserve beyond what you believe you’ll need so that when you hit an unexpected bump in the road, it doesn’t put you out of the game. And the bigger the reserve, the better. The bigger the reserve, the bigger the bump you can hit.
