How SMEs can avoid financial suicide

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NEARLY 80% of all small businesses fail within the first 18 months of operation. This “death rate” has become an accepted statistic by most economists.

NEARLY 80% of all small businesses fail within the first 18 months of operation. This “death rate” has become an accepted statistic by most economists.

However, the sad reality is that most small and medium enterprises (SMEs) don’t “die of natural causes but commit financial suicide”, obviously without intending to. We call it “suicide” in this article because most small businesses actually kill themselves without knowing it or intending to.

It is quite typical for entrepreneurs and small business owners to form bad financial habits and make harmful decisions that diminish the chances of success for their businesses, even when the underlying business model is quite sound. As responsible bankers who want to see the small business sector grow, it is our duty to advise the average SME how to avoid simple financial mistakes that make a big difference between long-term success or a quick and unpleasant sudden death of your business.

Not keeping basic financial records One of the many reasons why most small businesses sometimes collapse is because the owners fail to keep basic business records. Business records help the owner in assessing the health of the business, especially whether the business is making a profit or not. Financial records are like temperature readings of your business. They provide important and invaluable information that acts as an advance warning system to alert you before something goes wrong. Most times, businesses don’t fail without showing signs and symptoms. How else would you know that your costs are high and rising out of control if you don’t keep records of monies you’ve spent? How do you tell that your goods are being stolen by your employees if you are not regularly taking stock? Indeed, basic record keeping may require additional diligence and effort by the proprietor or manager of a business, but certainly will not cost a lot of money.

Neither does basic record keeping require specialised accounting skills. Oftentimes, it requires just business common sense and the basic ability to read and write and commitment of the business owner.

Records are essential for your bankers and one of the most important business records is your bank statements as a business. It is crucial for every business, no matter how small to have some form of relationship with an appropriate bank.

Because it requires commitment and diligence, recordkeeping also tells a story about both the owner and the business.

It demonstrates a level of seriousness and accountability. How can you be accountable when there are no records to prove it? How can any business succeed if it lacks the discipline to keep records? How can you know if you’re making profits (or losses) if you don’t write down or record your incomes and expenses?

Good records will help your bankers or other investors or creditors to assess your business for credit facilities. Confusing revenue and cashflows with profits Every business owner must understand the difference between these three important terms; Revenue (also known as sales or turnover) is the money that flows into your business from selling your products or providing your services to customers.

Profit, however, is the difference between money that flows into your business as sales revenue and money that flows out of your business as expenses. Also not all money that comes into the business is revenue, some money simply represents cashflows into the business, for example, the proceeds from a loan from a bank or an investment from a friend are not profits but an element of cashflow. As a business owner therefore, you should always be careful to separate these funds.

A business may have a huge amount of sales but may be generating losses. Even though your shop may be overflowing with customers and the tills are full at the end of the day, the business may actually be bleeding and losing money. So the trick is clearly understanding your costs in relation to your revenues.

Cashflows are, however, important to because cash helps one’s business to meet obligations in the short term when the business is still growing and may not be profitable.

Failure to distinguish cashflows and revenues from profits often leads to another deadly sin.

Not paying yourself a salary One fundamental principle of business is that the business and the owner should be separate entities. While the owner controls and runs the business it is often wise to think of the business as a seperate entity from the owner(s).

The money that is in the business belongs to the business, off course, until a dividend is paid from the profits. Unfortunately, most small business owners do not like this distinction and treat themselves and their businesses as one and the same.

This makes many good entrepreneurs treat their businesses like an ATM that will produce money for their private use and entertainment at any time. Danger lurks in running the business this way. It makes it difficult to ascertain the true costs of the business and therefore the true profits being made.

The way around this problem is for the business owner to be paid a salary if they are involved in the day to day running of the business. The salary must be commensurate with the size of the business, and the size of the work being put in by the owner manager. Don’t make the fatal mistake of confusing the business account and running it as a private account.

 Clive Mphambela is a banker. He writes in his capacity as advocacy officer for the Bankers’ Association of Zimbabwe. BAZ expressly invites players in the Microsmall and medium enterprises sector and all other stakeholders to give valuable comments and feedback related to this article to him on [email protected] or on numbers 04-744 686, 0772 206 913