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Common traps of small business owners

You’ve hung the shingle, flung open the doors and are now living the dream. The owner of your own business, the master of your destiny and a full card paying member of the economic powerhouse of the Australian economy — the small business sector.

Common traps of small business owners
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  • Stuart Donaldson
  • October 16, 2020
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Any straw poll of the sector, anywhere in the country and at any time, asking the same question — what are the two main attributes for starting your own business — will deliver the same resounding answer: passion and enthusiasm.

Great stuff, but as the years roll by and the challenges of building a successful enterprise mount, it becomes clear that passion and gut feel will get you only so far. As the owner, you are the jack of all trades. CEO, sales manager, production manager, HR manager, administration clerk, accounts clerk and the list goes on. There is a need to wear many hats, but can this frenzy of activity and noise overwhelm, and is there a risk you could become a victim of your own success? Given this, what is the solution?

Discipline, structure and rigour and, above all else, measuring and managing performance.

Too many business owners fail to realise they have the ultimate scorecard at their disposal year in, year out, and arguably during the year. Every business has a set of financial statements prepared by their accountant, but all too often, the expectation is these financials are for tax return purposes or to support a loan application with a bank. My advice is, ignore them at your peril.

The story of your business is found within, and there is a wealth of information. If you’re not looking, you’re not tracking, and there is a high probability you are falling victim to some of the many common traps.

Your financials will give insight to, and help make sure you avoid or resolve, such things as:

  • misuse of your short-term borrowing facilities (creditor accounts, overdraft)
  • poor working capital management
  • declining efficiency of your fixed assets in producing sales
  • shrinking profitability margins and lax expense control
  • excessive long-term debt, sub-optimal funding terms

Before we explore these examples in greater detail, let us try and understand why (in most cases) it happens. In a word, SALES! Many business owners are so focused on making sales (playing to their strengths) and so content the top line is growing they are vulnerable to lulling themselves into a false sense of security. There is a need to look beyond sales revenue and lift the bonnet to see what all this growth is doing to the business.

To mitigate against complacency, inefficiency, waste, wastage, creeping expenses and shrinking margins, a simple process of reviewing the key performance indicators, preferably monthly, will ensure focus and an ability to swiftly address areas of weakness or poor trends. This need only be a simple spreadsheet with a manageable number of indicators, for example:

 

KEY INDICATORS

2018

2019

2020

CASH FLOW

Current Ratio

2.32

1.88

1.60

Inventory Days Outstanding

79

73

104

Debtor Days Outstanding

25

36

50

PROFIT MARGINS

Net Profit Margin

2.30%

4.30%

3.40%

Gross Profit Margin

39.50%

40.00%

42.20%

ASSET MANAGEMENT

Sales to Assets ratio

4.17

4.00

2.78

Return on Assets

12.60%

19.67%

11.87%

Return on Investment

31.66%

67.58%

34.79%

BORROWING CAPACITY

Debt to Worth

2.35

2.97

2.67

Current Ratio

2.32

1.88

1.60

This simple illustration highlights that, at a glance, we can spot trends, for better or worse. It is clear where the focus needs to be and provides a foundation for an action plan. Any improvement in performance on any of these indicators will drive greater profitability and financial strength.

The single most common trap is misuse of the business overdraft. There are many reasons this can occur and one of the biggest culprits is ease of access. It is too easy to pay bills or buy things for the business when you have room on your overdraft; just reach for the cheque book and away you go.

Other contributors to poor working capital and a growing overdraft include debtor and stock management. If you are taking longer to collect your debtors or your stock isn’t selling as fast, you will put more pressure on the short-term funding sources. Over time, if this goes unchecked, it will get to the point you will be unable to clear your OD balance within the cycle of less than one year. Remember, short-term debt is required to fund short-term assets, and if you can’t clear this, you are now the proud owner of hardcore debt. The bank will recognise this through their own analysis and the best solution is to start amortising the debt over the long term.
 
High debt concentration and misuse of the overdraft are the main causes of distress (financially and emotionally) for business owners. It is avoidable and would take just a little refinement to your management and your process for measuring performance.

As a broker and a trusted adviser dealing with SMEs, all of the above is very good news. Hear me out. Once you know HOW to identify the common pitfalls, you have the opportunity to present to your clients not only the concerns but, more importantly, a range of solutions. As a third party to the business, you are taking the initiative to drive very positive change in their interest. This makes you a genuine and very valuable member of the team and a trusted adviser in the true sense of the expression.

Make sure your next review meeting has an agenda and a list of bullet points that have the potential to be game changers for your relationship.

Stuart Donaldson, business educator, Banyan Co

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