5 Warning Signs of Risk for Small Businesses

The owner of a small business or startup company needs to carefully monitor his business for warning signs of trouble. The majority of new businesses fail within three to five years. A small business does not have nearly the same margin for error as a large, established firm, and can much more easily be financially derailed into unprofitability or bankruptcy. If a small, relatively new business runs into financial problems, as the result of operational problems or a general industry or overall economic downturn, it is unlikely the business owner will have the same ability as a larger company with a longer history to access credit sufficient to weather the storm.

Another factor that makes a small business more vulnerable than a larger one is a small business generally has fewer sources of revenue than larger, more well-established companies. For example, a local "Mom and Pop" flower store with only one location in one city is in a much more precarious position in the marketplace than a nationwide chain of florist operations. The nationwide chain can make up for falling revenues in one area of the country with positive revenues generated in other areas, or it can utilize profits from some locations to at least temporarily cover losses suffered at other locations. It also has the option of closing unprofitable locations. In contrast, closing one location for the local Mom and Pop store means going out of business.

Larger businesses also typically have the advantage of being able to mitigate financial risk through a diversified product portfolio that offers multiple revenue streams from sales of a variety of products. A small business might be completely dependent on sales of only one or two products to generate income. Thus, it is much more vulnerable to shifting customer preferences and loss of market share to competitors.

It is critical that a small business quickly recognizes and addresses potential problems if it is to survive as a viable enterprise. Among the major warning signs of risk are declining or stagnant sales, cash flow problems, struggling to achieve or maintain profitability, lack of word of mouth or advertising generated business, and product quality problems.

1) Declining or Stagnant Sales

Growth is a major key to small business success. It is fine for a huge electric power company that has been in business for decades to have little year-to-year growth, but a small, startup company must aim to increase revenues rapidly to achieve profitability and survive. A significant warning sign for a small business owner is seeing sales declining or even flatlining prior to the business reaching the point of having a comfortable net profit margin. Declining sales can be a signal of basic lack of customer acceptance of the company's products in the marketplace, and is, therefore, an issue that must be addressed at the earliest sign of trouble.

Falling profit margins are a related warning sign. Unless decreasing profit margins are more than compensated by substantial increases in the number of sales, a decline usually indicates the existence of fundamental problems for the business. If the problems are quickly recognized, then steps can be taken to remedy the situation. But if they are ignored or left unattended, there is an increasing likelihood the business will suffer fatal financial collapse resulting from significant operational issues such as high production costs, inventory management issues or marketing problems.

2) Cash Flow Problems

Nearly all businesses, small or large, experience occasional, temporary cash flow problems. However, small businesses are more vulnerable to having a temporary cash flow problem snowball into financial insolvency. This is one of the main reasons small businesses need to follow good accounting practices, such as frequent bank reconciliations and careful overall money management. Making a small business successful usually requires balancing necessary expenses for growth with maintaining adequate cash flow to cover current operational expenses. At some point, having a good accountant on staff becomes a necessity. Prior to that, it is essential to have access, through an existing employee or an outside source, to reliable accounting services.

One common source of financial trouble for small businesses is expanding staff and payroll more rapidly than the company's revenues can support. A major financial warning sign is having difficulty meeting regular payroll requirements. If this situation arises, it should be addressed immediately and firmly, either by figuring out a way to quickly boost sales and/or profit margins, or through reducing expenses. One way to help avoid this potential problem is to have accurate projections of income, along with adequate consideration of how much additional revenue can be generated from the addition of another employee versus the cost of taking on the extra payroll expense.

It is obviously an advantage if the small business owner has established sufficient credit that enables him to borrow cash to meet unexpected cash flow problems. However, the very fact of having cash flow problems does not increase a borrower's creditworthiness in the eyes of lenders. A small business owner's chances of being able to obtain needed short-term, "emergency" financing are increased if he can show the lender the exact cause of the cash flow problem, along with adequate evidence the problem is only a temporary one and the business is taking steps to ensure it does not become an ongoing problem.

3) Lack of Word of Mouth or Advertising Generated Business

Small businesses that are just starting out have to market aggressively to get themselves known and accepted in the marketplace. This requires intensive sales and marketing efforts. However, for a business to survive long term, it has to eventually reach a point where unsolicited business comes to the company, either as a result of advertising or through word of mouth referrals.

A warning sign that a small business is at risk of failing exists when, after a company has been in business for a year or more, there are still no sales being generated that are not a direct result of the company making sales calls. If a company has a viable product or service to offer, and it has engaged in good initial marketing efforts, part of its growth should come from potential customers in the marketplace actively seeking the company's products or services without the company having to directly initiate contact with the customer and solicit sales.

4) Struggling to Achieve or Maintain Profitability

An unprofitable business cannot survive indefinitely. All businesses start out operating at a loss, as obviously some expenses have to be made before revenues can be generated. It is important for a small business to have planned a clear path to profitability and for the business owner to have a clear awareness of the steps he needs to take. The owner needs to know what results have to be produced from company expenditures to make the business a profitable one, and have a good projection as to when the business should begin to operate profitably.

The longer the span of time that stretches out without the business being able to achieve or consistently maintain profitable operations, the higher the risk of the business ultimately failing. Careful initial planning, reasonable performance projections, conscientious financial management and regular reviews of the company's operations and performance in relation to goals and projections are needed to meet profit goals. Even if a company is falling a bit behind schedule in becoming profitable, as long as the owner is carefully reviewing operations and making needed adjustments, there is still a good chance of ultimate success. If, however, despite careful planning, reviews and execution of plans, a small business is still having significant profit problems, this usually indicates a fundamentally flawed business model or serious operational problems.

5) Product Quality Problems

Product quality issues can signal major business risks for any company that manufactures and sells products. It is important to have processes in place for both monitoring product quality internally and for obtaining customer feedback regarding product quality. Many of the most successful businesses are those that do a superior job of eliciting customer input on how the company can improve its products to better serve the customers' needs or desires. This works well for small businesses that have the opportunity to make more personal connections with customers than is usually possible with large corporations.

A problem with product quality does not need not be fatal to a business as long as the problem is detected and successfully remedied as quickly as possible. Many a successful business has been propelled forward with the phrase "new and improved." Even when there are no specific problems with product quality, the smart owner of a small business continually looks at potential ways to improve products, lower production costs or offer supplementary products that customers may desire.




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