Financial distress for business owners can result from a variety of factors. Some causes are unforeseen and uncontrolled, like an economic downturn and regulation changes.
There are also plenty of causes of business distress that directly result from something the company or management did or failed to do.
This article focuses on what a business can control and foresee and what is required to turn a company from dying to thriving.
First, let’s consider why businesses need to be profitable.
Why Businesses Need To Be Profitable
Many startup businesses are in the red and then get to break even. However, to survive, companies need to make a profit, and there are several crucial reasons.
Profit is essential for the long-term sustainability of a business. It provides the necessary funds to cover operational expenses, invest in growth, and adapt to changing market conditions.
Investment and Growth
Businesses need to be competitive to attract customers and to do this, they need to become sustainable.
Funds are required for reinvestment in the business, which could involve expanding operations, developing new products or services, upgrading technology, or entering new markets.
Without profits, a business may struggle to fund these growth initiatives. If the funds can not come entirely from profit, the company must attract capital from investors.
Investors and lenders are more likely to support businesses that demonstrate a track record of profitability. Capital providers want to see a return on their investment through loans or equity investments, and profits signal that the business can deliver this.
Attract and Retain Staff
A profitable business can attract and retain talented employees by offering competitive salaries, benefits, and career development opportunities. Employees are more likely to stay with a company that can provide stability and growth.
Technology like AI and automation can do many tasks in most business areas today. However, human staff are needed for strategic roles in marketing and sales, customer support, and operations management.
Risk Management and Obligations
Profit serves as a buffer against unforeseen challenges and risks. It provides a financial cushion to help a business weather economic downturns, industry fluctuations, or unexpected expenses.
Businesses must meet various financial obligations, such as paying suppliers, servicing debts, and fulfilling employee commitments. A company may struggle to meet these obligations without profit, leading to economic instability.
Common Causes Of Financial Distress
Now we know why a business needs to be profitable, let’s look at common causes of financial distress.
1. Poor Financial Management and Cash Flow
Inadequate financial planning and monitoring is often the start of the demise of a business. Without it your business can not prepare of events that will challenge your revenue.
With enough revenue to cover expenses, your business can keep operating. However, there is always financial stress when a company is just breaking even. Any negative event can push the business into the red and negative cash flow.
To survive, all businesses need to be profitable. We recently updated an article on the topic of cash flow for the self-employed, in which many small businesses are budding startups.
Implement robust financial management practices, regularly review financial statements, and seek professional advice.
Improve invoicing and collections processes, negotiate better payment terms with suppliers, and maintain a cash reserve for emergencies.
2. High Levels of Debt
There are two types of debt. Good debt and bad debt. Which do you have? Good debt is typically associated with investments that have the potential to increase in value over time. Examples include student loans (investing in education), mortgages (investing in real estate), and business loans (investing in a business).
Loans for investments that also have low interest rates are the best. For example, mortgage rates and student loan rates are often lower than interest rates on credit cards
Excessive debt and high interest payments can strain finances. Additionally, all that debt will be weighing on your mind.
Restructure debt, negotiate with creditors for better terms, and focus on reducing unnecessary expenses.
Many small business owners use their home loans for business purposes because it is a lower interest rate than a standard business loan. However, this action does come with the risk that if the business fails, the loan repayments still need to be made and the loan repaid within the loan term.
3. Market Competition
Intense competition can erode profit margins and market share.
Conduct a thorough market analysis, differentiate products or services, and explore new markets or customer segments. Consider reading the book The Immutable Laws of Marketing to hone your strategies to become a leader in a new market with few or no competitors.
4. Operational Inefficiencies
Inefficient processes can lead to increased costs and reduced productivity.
Streamline operations, invest in technology for automation, and optimize the supply chain to enhance efficiency. Use SaaS, which spreads the cost of software services for managing your operations from bookkeeping to marketing.
5. Lack of Strategic Planning
The absence of a clear business strategy can result in poor decision-making. Operating your business without a plan is high risk.
Develop a strategic plan, set measurable goals, and regularly review and adapt the plan based on market conditions. Make sure to check your progress by also setting milestones so you know your business is doing what it needs to do to become sustainable.
6. Ineffective Marketing
Inadequate marketing can result in reduced customer acquisition and retention. Being the ‘world’s best-kept secret’ is not what you want for your business.
Invest in targeted marketing campaigns, enhance the online presence, and focus on building strong customer relationships.
Hire a marketing team who knows how to create a business presence on social media and create relevant content on your website to share with your followers and in a regular email marketing campaign. SEO is more vital today than ever as Google updates its search algorithms often. Is your website set up for Google Analytics 4?
Turning a company around often involves a combination of these strategies tailored to the specific challenges faced by the business.
Business owners can seek professional advice, engage with stakeholders, and proactively address financial distress to achieve long-term financial success.
Awareness of common causes and solutions will enable your business to reverse financial distress into financial success.