Is Lack of Capital the Real Problem?

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Conventional wisdom is that “a lack of capital,” or to put it another way, “inadequate capitalization,” is the leading cause of small business failure. That’s like saying that your heart stopping kills you, without mentioning that you got shot through the chest with a bullet! It (a lack of capital) is not the problem. It is a symptom of the problem.

The real question is why does a small business run out of capital? There are some important causes:

1. The owners had the wrong business plan. This could have been going into the wrong business from the start. Or, the initial plan for the business was flawed and decisions were made that put it on the wrong course for the money that it should have required to get going. Examples could be buying a building and using a bunch of cash versus leasing space, hiring too many people to start, not looking to the founders for enough of the seed money, and so much more—all the way to not having realistic marketing plans and projections or starting a business that didn’t have enough of a market for what it does.
2. The owners did not understand the concept of working capital. Cash plus accounts receivable minus short-term payables, credit card obligations and lines of credit balances is a number that has to be tracked and reported on continuously—maybe even daily. So many businesses do not have this information and the owners are blissfully unaware of the holes they are digging for themselves. Holes that they may not be able to get out of.
3. The owners pursued too many investments at the same time without understanding the full extent of the risk or their ability to make such commitments. This has certainly sunk many businesses. The owners are overly ambitious or overly optimistic about the results that they are likely to achieve with some of their new investments. The other problem is making investments that don’t relate to the core business vs. those that do. Even failed investments can have residual benefits that help the whole if they are complementary to the primary business.
4. The owners were not paying attention to the numbers of the business. It’s more than bad accounting that causes companies to run out of money, although that certainly can be a problem. It’s owners who don’t pay attention to the numbers they do have—or those who don’t know what is selling and don’t demand good cash flow forecasting so they can take action before the problem becomes a problem they can’t solve. When you are struggling to make a profit, or facing working capital shortages, you should be looking at everything on a daily basis. I have actually seen businesses that were in trouble reduce the frequency of their cash reports and forecasts, which is absolutely crazy in my opinion.
5. The owners weren’t committed to running a profitable, growing business. Some people think they can remain the same size forever, or go without a profit indefinitely, so they make decisions accordingly. Of course, they can’t because the world is changing around them. And it may seem hard to believe that someone could have the bulk of their net worth and their income coming from a business that they lose interest in, but it happens every day. There could be personal problems affecting them, or maybe they never really had a passion for what their company does from the start. Or perhaps they just got what they want and need in terms of material wealth and now just don’t care? It doesn’t matter because the end result is the same. Growth stops. No new investments are made or innovations are implemented.
6. The owners didn’t do what they should have done with marketing. So many business people see marketing as a cost to be minimized as opposed to an off-balance-sheet investment. I’ve had many business owners brag about spending little to nothing on marketing and then watch them fail later only to blame their demise on “the economy” or “the market.” My experience is that most companies that want to grow faster and be more profitable than their competitors have to spend more money on marketing than their competitors do.
7. The owners didn’t treat their people well enough that they stayed (and were motivated if they did stay). So many business owners today—in spite of record low rates of unemployment—act as if their labor is completely replaceable at a moment’s notice. Well it isn’t! You can’t pay the least required, not share information, not pay bonuses, not create opportunities for people to grow and learn, and then treat the people who work for you as if they have no choice but to do what you tell them to do and expect everything to work out. It won’t! Constant turnover will ruin the business.
8. The owners forgot that the clients and customers are most crucial to their success and instead got preoccupied with internal matters. How many times does this fundamental concept of a business, i.e., that its only reason for existence is to do or provide something that a client or customer wants or needs, get forgotten? And it will always lead to failure. You can’t look at a business through your lens. You have to do it through the eyes of your clients and customers. They want to deal with friendly, honest, energetic people who seem like what they do and care about them. They want good reliable products and services at a fair price that do what they are supposed to do. If you spend too much time on constant organizational reshuffling – or on policies and procedures, or worse, infighting—the business will unquestionably suffer.

Suffice it to say, there’s a whole lot that leads to running out of money.

If you are a business owner now, or think you will be in the future, make sure you aren’t making any of these common mistakes in your company and you will probably do pretty well.