Failures happen long before failures happen. It is a little known fact that the great Roman Empire showed signs of failure long before the official demise. Prior to the official fall Alaric besieged the city twice but was brought off with gold and precious artifacts. Before the official decline of a nation or business signs of deterioration are evident. Small businesses need to be keenly aware of failure signs, many of which go undetected before it’s too late. These signs can be detected only through financial analysis. Sadly many small businesses and there Accountants do not really analyze finances they simply organize and report it. This is a huge missed opportunity for many firms. The following are a few areas which small businesses should monitor to locate signs of financial stress.
When constructing a home, a crack in the foundation is typically a major concern. The entire structure rests on the soundness of the foundation. A small crack in the foundation puts the entire unit at risk of collapse. The failures of many businesses begin as small cracks. They seem insignificant at first but are the beginning of larger issues.
One of the most important indicators of financial stress is an organizations cash position. How is the cash flow in the organization? A small business can have thousands of clients but if the cash flow is incorrect, prepare for a failure. Is cash steadily decreasing from month to month? This indicates that the organization may have more fixed expenses then revenue. How much cash does the organization have in comparison to prior years? Huge changes could mean large capital investments in the organization. These should be monitored carefully. Cash is of particular concern for startups as they typically lack access to credit arrangements. A startup that does not wisely spend startup funds to produce revenue is doomed. Monitoring the cash position of the firm is a key task which no business should overlook. Monitoring the cash position goes beyond the bank balance but understanding what that figure means. For example we recently completed a preliminary analysis for a Non-profit which revealed some concerns about incoming revenue. On the surface the organization experienced a 40% jump in revenue when compared to the prior year. However, after a deeper dive we learned this figure was inflated. It included a large transfer from an investment account. When we excluded this cash infusion the year over year change in cash was more like a decrease of 10%. This means the organization was funding there day to day operations from their rainy day fund rather than incoming revenue. This of course is a no-no in the world of finance and is known as a structural imbalance. Signs of cash stress can be located with a variety of analysis techniques such as flux and ratio analysis. A white paper we authored titled “Business Improvement and Performance Analysis with Microsoft Excel” will supply a little more detail about these approaches.
Another overlooked opportunity to locate financial issues is through process analysis. So many organizations are producing deficits because of inefficient or misaligned processes. Every organization should: document how long it takes to deliver a service(s)\ product(s)? Who is completing each task? What are their salaries? Are there opportunities to decrease the time involved in the process through streamlining? Intuitively a longer process equals more money. A quicker more efficient process implies cost savings in most cases. A financial process analysis can reveal opportunities for major dollar savings.
The signs of business failure are by nature covert. They lurk in the dark hiding from the vision of the owner. It is only through financial analysis can light be shed on these creatures that seek to destroy our businesses.