Head in the clouds, feet on the ground

Once a month, Deloitte Private Partner, Stephen Nicholas will deliver his thoughts on a hot topic in the world of SME's. This month he's offering his top five tips on how to turn anticipated success into reality.

§    A commitment to hard work and personal sacrifice.

§    Enthusiasm, tenacity and the appropriate level of self-confidence.

§    A product, skill, or service that is marketable.

§    Managerial, administration and marketing skills.

§    Adequate financial resources.

Many people think about leaping into small business in order to buy a job. That’s wrong. For all the rewards of being one’s own boss, many things people often take for granted as an employee — job security, set hours of work, known and guaranteed income, holiday and sick pay, and long service leave — aren’t part of the package.

Business start-up statistics in New Zealand suggest how many aspirants fare with such a lack:  About 10% of all small businesses fail outright within their first year, and some 70% will cease operations within the first five years.

Among the reasons for such failure are poor management, sloppy records, stock (too much or too little), bad planning, misuse of time, lack of marketing smarts, and general management incompetence. For all that, however, the most common excuses for business failure are usually to do with the supposed business climate, finance costs and difficulties, demand slumps, and regulations.

But well-managed businesses will weather storms. That’s because they will have proper financial information, use written business plans with future development and expansion guidelines, have an adequate product mix and not rely too heavily on one small group of customers or clients.

There are many signs on the road to failure and if these are addressed then survival is more likely to be assured:

Insufficient Capital: This makes it difficult to get the business from start-up, with no sales, to break even and then to sustainable profits. A growing business uses up cash significantly faster than a business maintaining its position. 

Partnership Problems: Partners should be selected in the same way as employees are selected - on the basis of their ability to contribute to the business and help achieve its goals. Too often partners are selected simply because they are relatives or friends or willing to contribute an amount of capital. So consider the skills required for the business, have job descriptions and a basic organisational chart.

Lack of Management Expertise: A detailed business plan is essential, not only for raising capital but to act as a blueprint for future business growth.  Make sure you have the necessary expertise in your chosen business field.

High Gearing: Borrowing excessively means a greater portion of gross profit is directed towards finance costs. Cash flow also gets drained by principal repayments.

Incorrect Pricing Policies: Too often prices are set to market realities rather than to cost-recovery and generating profit.  Efficient service or added value can be more important than price alone. Unless you can make an adequate margin of profit, you are, well, doomed.

Marketing: Many small businesses go broke simply because they don’t sell enough product or they fail to keep abreast of market, operating and technological changes. Remember that in business nothing is constant. You must continually update what you’re offering to stay in tune with market demands.

Cashflow and Profit: Any business that fails to forecast its cashflow appropriately is headed for trouble. Without accurate cashflow projections, management is unable to identify future cash requirements. And that means it lacks vital information about the financial direction of the business.

However, “cash flowing” alone is not enough; the business must be returning a profit.  The long-term trend of both must be positive. Ideally, a business should have a budget showing expected future income and expense levels and the minimum return to the owner.

It is vital for each business manager to know the point at which an operation is going to break even. This is the point at which the gross profit (“revenue less direct costs”) equals total fixed costs. Any additional turnover will result in a profit equal to the gross profit on this turnover, and any reduction in turnover will result in a loss - as all fixed costs are not met. Knowing, and monitoring, these revenue levels will equip the owner to know, from month to month, how the business is performing.

Low profit months will generally impact on cash flow in the current and following periods. Therefore the ups and downs in turnover will usually be mirrored in cash flow projections. That’s where the importance of the interaction between profitability and cash flow projections comes in.

If you want to be successful in business, don’t fool yourself: it will require hard work and skills. But if you know what you are in for, you are more likely to survive. And thrive.

Stephen is a Wellington Deloitte Private Partner advising fast growing and entrepreneurial companies.