The One Important Factor That Impacts The Bottom Line For Small Businesses
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Good news for entrepreneurs: it has never been easier to start a business than it is now. The internet has given just about anyone access to a global economy with quickly increasing consumer demand, and access to tools and technology which not that long ago was only accessible by large business with seemingly endless sources of capital.
Increased opportunity however, means that the stakes couldn’t be higher, and the difference between success and failure oftentimes comes down to a few critical decisions. Did you know that in 2014, 390,000 businesses failed in the United States?
The number may seem staggering, and all but guarantees the producers of Shark Tank will have enough work for a lifetime. Before you quit your 9-5 and become your own boss, it’s important to understand just why so many businesses don’t make it out of the garage. According to a recent Business Insider report, here are the top reasons why most small businesses fail:
- 19% are outcompeted
- 23% don’t have the right team
- 29% run out of cash
- 42% no market need for products or services
- 82% experience cash flow problems
Turns out being an entrepreneur isn’t easy. Adding to these challenges, most small businesses still use paper checks and invoices, which means even when they have cash, they probably don’t know exactly how much they have at any given moment, or where it’s being spent.
Still creating, accessing, and managing cash flow is a serious issue for small businesses. Two of the top five reasons small businesses fail have a direct connection to cash flow issues.
Cash can be pretty hard to come by for some businesses. That may seem untrue if you live in Silicon Valley, where startups are getting funded left and right. But let’s be real, most of us won’t become the next Steve Jobs (and if you are, give me a call), so learning how to create proper cash flow can often times be a make or break for a small business.
And when I say focus on it, I mean make it everything you think about. The most successful businesses have products that their customers can’t live without. In fact, a key factor I look at when evaluating the potential success of a small business is how disappointed their customers would be without it, rather than how much they like it. This small, seemingly trivial detail actually reveals a whole lot about what someone is willing to pay for your product, and if they’re willing to tell their friends about it.
Why is that so critical? It helps in three major areas that in turn, make you lots of money:
1. They stick around No matter how good of a sales pitch you have, if your customers churn out faster than you can recover the cash it took to acquire them, your business will soon struggle to maintain cash flow. Retention should be a high priority as a business owner. Why? Increasing customer retention rates by 5% increases profits by 25% to 95%, and 82% of companies agree that retention is cheaper to execute than acquisition. Retention is also a key indicator of product-market, which is arguably the most important keys to business success.
2. It costs you nothing to acquire a customer from a referral (a customer who loves you) One of the most famous instances of a great product, fueled by viral/referral growth is Dropbox. Dropbox initially tried paid search ads to acquire customers, but realized that the cost to acquire that customer was 3X their first year revenue (it only costs $99/year). That’s not a sustainable business model no matter what way you cut it. Build a great product that people love, and you’ll find a bit more cash in your pocket.
3. A great product and customer experience means you have leverage Leverage means you can command margin. Ask any sharp accountant, and they would recommend you look at your gross profit margin as a percentage of sales. There is no better example of this than Amazon. They started with one product category (books) in the early days and by obsessing about using technology to serve their customers. Their product is convenience, and that overwhelming product experience creates the leverage you need to command margin. Want a great example of how this works in reverse? Look at airlines– in 2016, total operating revenue for the 25 U.S. scheduled passenger airlines in 2016 was $168.2 billion. Almost all of them lost money or broke even, and the reason is leverage. If your business or product can’t compete on anything but price, you’re going to have a tough time making any money.