A lot of businesses fail because of financial mismanagement. Finance is the blood of any business. Its flow must be carefully watched and regulated. If finances are not handled properly, it may prove to be risky for a business. The risk associated with finance must be planned for. Here are some sources of financial risk in a business along with suggestions to safeguard against them.
Unrealistic Sales Targets
When a business starts, generally there prevails a lot of optimism about the scope of its products or services. Only time can tell the validity of that optimism. Sometimes, the optimistic assumptions about sales do not stand the test of time. More often than not, a new company cannot achieve its projected sales targets. If the company is not able to generate sales as per the projections, its financials go for a toss and a lot of trouble starts. Right in the beginning, we must conduct a proper and realistic break-even point analysis of our business and project income and expenses in such a way that the business should be able to sustain periodic setbacks in income. We must have a plan ‘B’ or plan ‘C’ for financing our operations, if sales income is affected adversely.
Profitability Miscalculations
Underestimating costs and overestimating profitability is one common error found in many new business ventures. Eventually, the reality sinks in. Profit does not come into our account as much as we had projected or hoped. We must calculate costs as realistically as possible and must not ignore any hidden costs. Costing experts can help us in having thorough costing calculations.
Interest Burden
Many companies go down because of too much of borrowing or “over leveraging”. Every business needs money. All the money is not financed through the capital invested by the promoters. So, some money is borrowed on interest. The cost and magnitude of this borrowed money must be watched extremely carefully. Sometimes, business leaders borrow too much money at high interest rates. The traditional sources like banks and financial institutions don’t lend businesses money beyond a certain level. When loans are not available through such traditional, low-cost sources, some business leaders make a mistake of borrowing from other high-cost sources of money. If the profit margin of the company is not good enough, the interest burden of these borrowings becomes too heavy which the business can’t service. Sometimes, businesses have to borrow more to pay interest on the loans taken earlier. This is a very bad situation to get into. We must undertake pragmatic financial planning taking into consideration the cost of money used in the business. We must not borrow beyond out capacity to pay the interest and to repay the loan within a reasonable time.
Cash-flow Mismanagement
Business leaders must be watchful about from where the money will come and where will it go. Sometimes, some sudden purchases, unexpected payments or unplanned investments take out money from the business, which affects the regular operations. In some cases, lenders who had given money for a short term, suddenly demand for their money back, creating a big hole in the company’s cash-flow. Shortage of money delays regular payments, delaying some important projects or affecting the reputation among the creditors. Cash-flow must be planned and executed meticulously. The leaders of the business must ensure that the next few months’ cash-flow projections are made as realistically as possible and cash is used as per the plan. They must watch cash-flow regularly and plan for contingencies and emergencies.
Bad Investments
When some money is surplus in a business, it requires proper investment. Sometimes, business leaders invest such money into assets which prove to be risky. Some such assets (e.g. stock/commodity market investments) are prone to market risks. Others (e.g. real estate) may face liquidity risk and can’t be sold when desired without losing money. Investments must be done with careful examination of risk-reward ratio. Mind should matter more over heart in investment decisions.
No Proper Exit Strategy
When actual implementation starts, all business plans don’t go as projected in the Excel sheets. A lot of uncertainties and unpredictable events drive reality, sometimes leading businesses into rough and hostile waters. Business failures are not uncommon. Bad timing, unrealistic optimism, adverse market conditions, leadership failures, errors of judgment, financial or other mismanagement, unforeseen circumstances or some other reasons may contribute to the difficult times for a business. If the business does not do well in spite of making all reasonable efforts to keep it floating, the business leaders must take a pragmatic approach in deciding about its future course. Empty hope and baseless optimism must be weighed against harsh realities and rational assessment of the prevailing conditions. Lives can be saved from a sinking ship, if action is taken early. As precious time goes, the ship will gather more water leading it deeper inside. A losing business in a hopeless terrain may widen its losses further, if firm and resolute action is not taken in time. If all attempts of revival fail, business winding up operations must be initiated. In stock market trading, there is always a “stop loss” strategy. Business leaders must also have such a strategy to ensure that the business does not incur losses beyond a certain level. If it does, it may ruin too many lives forever. It is advisable to avoid such a total ruin, if possible.
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