Summary of the Article:
- Although SMEs are important contributors to the economy, lack of finances are cited as a major cause of their failure. However, this blanket statement has more facets to it than the simple statement implies.
- Some key issues that lead to the death of high turnover businesses include:
- Struggling cash flows & loss of control in finances
- Ignorance of true profit position and/ or High revenues but very low profits
- Statutory noncompliance especially with tax requirements
- Poor processes and procedures
- This article suggests tips for such businesses to remain in operation.
Small Businesses, Huge Contribution
People start businesses for a myriad of reasons. Whatever the motive, no one starts a business to fail. Yet it is a gamble: you never know whether your idea is just what the market is looking for at the minute, or if it is a delusional idea that will never catch on. This is the heart of what it means to be an entrepreneur: that willingness to take on an element of risk. Most entrepreneurs will start their businesses as SMEs.
Did you know that SMEs form about 90% of businesses and represent more than 50% of employment worldwide? [1] That means that every other person you meet likely derives their livelihood from an SME! SMEs and informal enterprises contribute over 95% of total employment and about 70% of GDP in middle-income countries (of which Kenya is an example). For low-income countries, SMEs and informal enterprises account for over 60% of GDP and over 70% of total employment [2].
A Grim Account
For all their economic significance, access to finance is still a key constraint to the growth of a lot of SMEs; it is the second most cited obstacle hindering SMEs to grow their businesses in emerging markets and developing countries [1]. We have all heard the dreary statistics about the success rates of SMEs. The actual failure rate for Kenyan SMEs according to studies is 70% within the first three years [3]. While there are various causes for SME failure, finances have a significant role to play in this.
The statement “lack of finances is a major cause of SME failure” is more complex than it reads. A lot of failing businesses do not crumble because they have a poor product, or lack of sales – no! Nor do they collapse because they get into the market at the wrong time. Surprisingly, some of the businesses that go into demise usually have a very robust turnover. So, what causes such potentially strong business to fall? Here are the major causes, and some tips on how to avoid these issues:
Cash Flow Problems
This refers mainly to problems with working capital where the business is unable to meet short term obligations such as paying suppliers, salaries, etc. despite continued high sales. As a result, the business faces cash flow disruptions and loses control of its finances. This may also disrupt the business’s ability to supply to customers.
Although profit is a good business performance metric, it does not always guarantee business continuity. Some of the causes of cash flow disruption include slow debtor repayments versus strict supplier credit terms; difficulty getting funding for your working capital needs; and heavy debt financing with crippling interest repayments. How do you manage these?
As a business owner you need to keep an eye on your cash and be very prudent about balancing your inflows versus your outflows. Obviously, this is easier said than done and each business has a unique operating model. It is crucial that you keep an eye on the cash levels at any given time, plan and forecast your short-term needs, manage stakeholders appropriately and have some security funds to cushion you against unforeseen needs.
Inadequate Records
The more the business grows, the more important it becomes to maintain proper accounts for the purpose of data driven decision making. Yet a lot of businesses maintain poor records of their operations and transactions. Sometimes business owners believe they are profitable because at the start of the business they were making profits, not realizing that their business model was not correctly setup to grow profitably. At any point in time, the business owner must keep an eye on the business profit or loss position and make the relevant decisions based on this. Nothing should catch you by surprise.
Although at the beginning a simple Excel sheet might allow you to keep track of your income, expenses and financial position, as the business expands and becomes more sophisticated, be ready to invest in more robust systems. You also need to employ a competent professional to help you keep organized and on top of your finances.
Statutory Noncompliance and Related Penalties
This is the elephant in the room. Many businesses think they can get away with evading taxes, but beware as this could be the loose thread that unravels your business fabric. In fact, in many cases this is a huge cause of business failure. Further, as the business gets bigger, its structure often changes, bringing along with it additional statutory requirements, compliance risks and possible penalties due to defaults. This is especially true for taxes, but there may be other regulatory requirements.
Ensure you are compliant with the applicable laws, or get a professional to advise you on what is required before you get penalized. This is one of those matters for which you should definitely get professional help as the tax environment is constantly evolving and you need an advisor who is up to date with the relevant laws.
Poor Processes and Procedures
This is another massive source of failure for small businesses. The processes and procedures of a business are its spine, and they need to evolve and strengthen as the business grows. By analogy, think of an infant who starts out with a pliant spine. As they mature their spine needs to firm up to be able to hold their body frame, but still be flexible enough to allow comfortable movement. The same applies to a business.
Many founders are unable to create appropriate processes and procedures to keep up with the changes in their enterprise. Instead, they apply wasteful and inefficient patch processes to manage the mess that results from being unprepared for growth. From the very beginning, business owners must think about how to scale their businesses and pace their growth so that it does not become a source of disaster rather than the much-desired profit growth. Every business is unique. AS such, careful thought must go into designing appropriate processes for the business rather than employing a cut-and-paste approach.
The Help You Require
“Everything is possible. The impossible just takes longer.” -Dan Brown.
Does all this sound intimidating? Unworkable? Too much? Be assured that with the right help your business can live beyond its sixth anniversary.
Red Beryl professionals have experience from large established corporates who have likewise worked with small budding businesses. We therefore understand the peculiar challenges facing growing enterprises and understand what it takes to get them to expand sustainably with proper structures and operate profitably. If you are ready to grow your business to the next level, please email us on ask@rbconsulting-ltd.com or call +254(0)723673615.
References
[1] The World Bank Group, “Small and Medium Enterprises (SMEs) Finance,” [Online]. Available:
https://www.worldbank.org/en/topic/smefinance
[2] H. Keskin, C. Sentürk, O. Sungur and H. M. Kiris, “The Importance of SMEs in Developing
Economies,” in 2 International Symposium on Sustainable Development, Sarajevo, 2010. Available: https://core.ac.uk/download/pdf/153446896.pdf
[3] J. Douglas, A. Douglas, D. Muturi and J. Ochieng, “An Exploratory Study of Critical Success Factors
for SMEs in Kenya,” in 20th International Conference on Excellence in Services, Verona, Italy, 2017. Available: https://www.researchgate.net/publication/319930935_An_Exploratory_Study_of_Critical_Success_Factors_for_SMEs_in_Kenya
