You’re a small business owner, but you don’t know what the most common financial risks your company might be exposed to are. Whether you are an online business or a brick-and-mortar store, without the right information you might make a bad decision. Here we explain the 10 financial risks every small business should be aware of and start planning for the future.
Before we get to that, let’s review some statistics.
Small businesses form an integral part of a country’s economy. There are 31.7 million small-scale companies in the US alone. They account for 64% of the jobs created in the country. But, all is not hunky-dory.
More than 50% of small businesses fail in the first year, and over 95% fail within the first five years. The primary reason for their failure is the lack of market demand.
Besides, 66% face financial challenges. Paying operating expenses is the most significant challenge for 43% of small businesses. This comes after work from home became a norm, with 1 out of 4 Americans working remotely this year — reducing costs for the companies.
Moreover, 60% of companies went out of business due to the pandemic in 2020. They could not adapt to the evolving market conditions or have enough cash reserves to sustain!
Entrepreneurs make many mistakes before they learn to lower their financial losses. You do not need to follow that path. Take note of these ten financial risks that will help you make wiser business decisions in the days to come.
This article contains:
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- 10 Financial Risks Your Small Business Needs to Know
- Under-pricing Business Offerings
- Taking Accounts Receivables Lightly
- Getting a Loan Unnecessarily
- Relying on a Single Funding Channel
- Hiring People Without the Funds to Afford It
- Recruiting People Without Much Thought
- Depending on One Source of Revenue
- Not Accounting for Liquidity Risk
- Choosing the Wrong Investor
- Operating Without a Legal Framework
- Control Your Business Finances
10 financial risks your small business needs to know
1. Under-pricing business offerings
Many entrepreneurs tend to set lower price levels for their products or services at the early stage of their businesses. Since they have not made a name for themselves in the market, pricing is the only differentiator to beat the competition. Fair enough.
But when operating costs increase, so do the need to increase the prices. Of course, loyal customers could get offended when that happens and feel that the price increase is unfair. But in the long run, no business can make a profit if the prices are too low!
So, how do you overcome the problem? Through extensive market research on your offerings. This comes in handy when you have to justify the increase in prices to your customers or referrals.
You are clear about how your offerings stand apart from the competition. It is not about what you charge but what you offer to your customer base at the end of the day. Thus, avoid suffering losses by under-pricing your business.
2. Taking your accounts receivables lightly
Have you ever made a note of how the money is flowing in and out of your business? Are you extending the deadline for your customers to pay? Are incurring necessary business expenditures from the bottom line? That is not viable in the long run and would dry up your cash flow.
You need to “make money” on whatever product or service you offer to your customers. Let us take an example. 60% of your revenues come from a single large-scale customer. But keep extending their credit limit.
What if you have a loan that is due shortly, but you do not have the financial resources to clear the amount? That debt is only going to increase your financial risks.
If that customer cannot pay on time for whatever reason, you are setting yourself up for massive financial turmoil. So, be firm when it comes to getting your invoices cleared on time.
When revenue is lost for two months, 86% of small businesses have to supplement funding or cut costs. Are you willing to be in that scenario?
It is necessary to keep track of your accounts receivables to avoid any financial losses. Your business success depends on your capability to bring the money that your customers owe you into the cash flow — on time!
Whether you’re a small or startup business, also make sure you have the right startup business credit card to keep track of all your expenses at each stage of your business!
3. Getting a loan unnecessarily
In 2020, the US government gave nine million loans to SMEs, totaling $750 billion. The same year, small businesses experienced a 14% credit growth.
Procuring a loan for your business feels like a great accomplishment. Having that extra money in the bank account opens up many opportunities! Yet, you should not get a loan because you can!
Banks make money on business loans through interest. So if entrepreneurs want to lower the financial risks of paying off the associated costs that come with borrowing money, they should not get a loan at all. The same holds true if you take help from an angel investor.
Everyone needs to be paid back. Therefore, you must raise funds only when it is indispensable. Whenever you decide to raise funds, you must ensure you can meet its repayments.
A failure to follow the terms of the loan carries severe penalties. These costs decrease the ROI and diminish your chances of getting a loan in the future because of faulty credit history. You do not want that for your small business.
4. Relying on a single funding channel
As a small business owner, you must consider all the funding options available to you. Of course, in the initial stages, you could get funds from your family and friends. But raising startup capital does not have to be restricted to those channels only.
You can seek venture capital and pre-seed funds besides taking help from angel investors. Also, look up government support programs for small businesses. Having little money is better than having no money to fuel your business vision.
It is worth taking the time to diversify funding channels and picking the most appropriate option — one with small financial risks and low interests. That is the sign of a strong capital strategy.
5. Hiring people without the funds to afford it
One of the most common financial risks that entrepreneurs take on themselves is hiring staff based on promises without actual money in the bank account to pay them.
This often happens when you think your cash flow will improve. For example, a large-scale customer will pay for your service, or a bank is about to sanction a loan.
But what if that money gets delayed or you never receive it? Even if the arrangement with the employee is contractual and the person works for you remotely, you would still need to take care of their payments whenever they raise an invoice.
Small businesses are twice as likely to hire full-time remote employees. Whether you have a remote setup or not, resist the urge to hire people until you have the appropriate amount of funds.
6. Recruiting people without much thought
The increase in staff numbers is often seen as a sign of a growing and healthy business. That could not be more wrong. Companies like Waldron Private Wealth, The Indigo Road, and Spikeball are worth millions. But do not have an employee strength of more than 50!
Every person working in your small business should be justifiably compensated. Whether it is for developing new products, generating leads, or serving the customers — you must be cautious about setting up too many positions to fill.
Buffer is a remote company with an employee strength of only 85. Although the individuals are spread throughout the globe, they efficiently service more than 73,000 customers. What they not do is hire unnecessarily.
If some of the employees do not produce anything or make your small business money, they are overhead expenses for you. It would also get difficult to regulate them over time if you continue filling too many positions quickly.
Even if you have the funds to afford them, the arrangement will increase your financial risks and significantly decrease your company’s overall ROI. Employ only those professionals who directly boost business value.
Save as much money as you can. Use it as insurance money in case of any emergencies. What if you have to pull up your socks and support your business (and employees)?
7. Depending on one source of revenue
As a small business, you are bound to have a limited customer base initially with one or two major clients. That is okay in the short run. But you must seek diverse revenue sources if you want to grow your business without worrying about the cash flow.
If you do not, your financial risks could be significant if one or both decide to cancel your service. Think of your business as a stock portfolio. It would help if you had a variety on your plate — irrespective of the product or service you sell.
Unfortunately, small business owners often get so busy serving early customers that they do not get time to venture into other markets. When the realization kicks in, those early revenue streams have already thinned down.
Therefore, start marketing your services to diversify your customer base. Strengthen your networking capabilities — attend events and seminars — and do paid campaigns (if budget persists) to increase your visibility in the market and earn more customers in the process.
8. Not accounting for liquidity risk
The term refers to the level of risk involved in ensuring that the business assets transform into available cash. This is often a financial risk for seasonal companies subject to regular downturns in trade during lean periods.
Examples of such small businesses include Halloween or Christmas retailers, moving service providers, snow removal service providers, and vacation cottages.
When an entrepreneur is unable to source more products or pay its staff, it can lead to significant problems that can hamper the business’ longevity. In extreme scenarios, this can even result in the closure of the company.
Therefore, you must monitor and control liquidity regularly. In addition, consider any banking compliance regulations that could potentially limit the transferability of your liquid assets when you desire.
Project future cash flows from assets, liabilities, and other items not on your balance sheet so that you can identify liquidity risk and be prepared before a shortfall occurs.
As a small business, you would not have to deal with huge numbers currently. Hence, cultivate a habit to do this exercise. Keep your business safe from all sorts of financial risks.
9. Choosing the wrong investor
Every investor is different and contributes differently to any company they invest in. Unfortunately, too many small businesses take the money right away when they should spend more time defining who the right investors are for them.
If your small business decides to go for an investor, think beyond the compliance and background checks, and ask yourself, “what type of investor do I want onboard?”
For starters, they should be able to provide to your business whenever there is a cash crunch. Companies with investors who are willing to offer more capital often succeed over those that do not. Can your investor minimize your financial risks?
Virtual matchmaking has become huge in the world of investors ever since the pandemic closed doors on all live events. Apart from giving you valuable advice, your investor should ideally be able to provide your small business access to their professional network, thereby increasing visibility.
The right investor can dramatically increase the chances of your small business success. But before you say yes to anyone, you have to be sure that they are financially sound and help raise your bar in the market.
Most investors will jump at the opportunity of investing in what appears to be a high-yield investment, but you need to consider what they will bring to the table as an investor in your company.
10. Operating without a legal framework
Yes, that is right — negligence in being compliant can cause your business to incur financial losses. For instance, if you misunderstand a specific law and do not deposit some documents to the authority regulating that law, you could be liable to pay penalties.
In another case, if you specifically run an LLC, you may forget to properly document LLC activities apart from the files Articles of Organization and a bunch of unsigned template documents. Again, carelessness can discredit the entire existence of your LLC.
Worse, if there are other partners in the business, they can sue you for not complying with the law. On the other hand, if you fail to meet the terms of the contract with a vendor due to delay or lack of funds, you can be sued by the latter.
Plus, if you are dealing with remote employees, you need to lay down the rules of their employment firmly. It is necessary to be transparent about what is ethical and acceptable when working remotely for your business.
Having two full-time remote jobs, for instance, is not ethical. You cannot invest in an individual who does not comply with the legalities. Any form of contractual risk can also lead to financial losses for your small business.
Your business finances are in your control
Although you will never be able to entirely eliminate financial risks, planning proactively to negate them will undoubtedly help. Be sensible about how and where you invest your money as the right choice will help you protect the trust and reputation you have worked so hard to achieve.
Build a business plan in case you do not have one and research the market. Keep an eye on your cash flow, ensure your customers pay on time, and diversify your revenue sources as much as you can.
Besides, try not to hire people unless you have to or indulge in unnecessary expenses (such as purchasing a technology software you do not need). This is especially important when your team is remote and having operational transparency can be an issue if not tackled properly.
Pandemic or not, you must reduce your business risk by keeping a stronghold on your finances. Build a successful company or close up shop early in the game — achieving the end goal is in your hands.
Gaurav Belani is a senior SEO and content marketing analyst at Growfusely, a content marketing agency that specialises in content and data-driven SEO. With more than seven years of experience in digital marketing, his articles have been featured on popular online publications related to EdTech, Business, Startups, and many more.