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 As mentioned in our Business Start Up article, the SBA suggests that 1 in 3 businesses fail in the first two years for two main reasons:
1. Lack of overall planning
2. Underestimating how much capital is needed to start and sustain your business until it can turn a profit
Arguably, those are the two most misunderstood elements of planning any new business, because they take the most work, thought, and expertise to complete. These are often the areas where new business owners don't have enough experience, don't know how to do the right research, or are just plain to lazy.
The third reason most businesses fail is the lack of controls, or metrics, in the business itself. We'll explain that later as we tackle each one of these common mistakes separately.
Planning
Lack of planning is a pretty broad topic, but it speaks to a more general problem with start ups in that most entrepreneurs spend time figuring out their 30 second elevator speech without spending time on the nitty gritty. Really getting in there and outlining the details of the business, the day to day operations if you will. The micro level operations. It's one thing to know the business from the macro: ie what market are we in, or what product do we sell, or what is the future of my product or service? These are necessary generalities you should concern yourself with, but you need to drill down further to really get an understanding of what makes your industry tick. If you think of planning your business as a road map, the macro issues are the paper the map is written on, while the micro issues are the actual roads, highways, and traffic signs that will get you where you ultimately want to go.
Macro Planning
When planning your business you want to have a clear end goal. This is looking at it on a macro level. It can be as far out as you can imagine or it can be just a few years away. The point is to make that goal be the culmination of all your work. That goal will be the thing you could have right now if you could wave your magic wand and everything you wanted was granted. Maybe that goal is financial freedom, having enough money invested not to work any longer, or making your business so profitable that it could be sold for an amount of money on which you could retire comfortably. Think big here. Do you have it in your head? Can you feel how nice it is to be free? Exciting isn't it. This is where most entrepreneurs stop. They get the goal in their mind and they just start picking up the phone to make it happen, without really having a plan. Take the next steps, looking at your business on a micro level to understand whether the goals you've set are realistic or whether they need to be changed.
Micro Planning
After you've established your end goal, think about the things you would need to obtain, obstacles to climb, or the steps you'd need to take to make that goal happen. It helps to think about this in broad strokes for now. For example, if your end goal is to retire at age 50 with $10 million in the bank how would you make that happen? Well, if you were 30 years old today, you'd have 20 years to accumulate $10 million, or on average you'd need to net $500,000 per year over that time period. Looking at it in this way helps you break that end goal down into smaller, more manageable steps, that are clear, achievable, and realistic.
You can take that a step further in the micro planning process by relating that dollar amount to how many products or services you'd need to sell. For instance, if you're a consultant who charges $100 per hour and you determined that you need to average $500,000 per year, you'd need to book a minimum of 5,000 hours of work, not including some extra hours to cover all your costs. At a 40 hour work week, you'd need 125 weeks in the year to make the money you need to hit your goal. Right away you can tell that's not possible. There's just not enough time.
Would the market bare a higher consultant fee? Working only 50 weeks out of the year at 40 hours per week would require you to charge $250 per hour to make the $500,000 per year mark. If the market will not bare that hourly rate this business will never allow you to hit your goals. At this point you need to re-conceive. Adjust your goal to be more realistic, or adjust your business, within reason and within market limits, to get you closer to the goal.
From a products standpoint, look at it this way. Suppose you're selling skin care products at $25 per box. You'd need to sell 20,000 units to make your goal, plus a few more to pay for the costs of production of those products. Next you'd have to ask yourself whether it is feasible to sell that many units. Is the market big enough, and can you reach enough of the market to sell that many? If not, you need to raise the price or lower your goal.
Just doing those simple steps above puts you into a category apart from most entrepreneurs who don't take the time to look at the numbers so closely. You'll be better off for it though, as you'll have a more holistic view of your business and what kind of work it will take for you to be successful and reach your goals. That's just the first step in overall business planning.
Start Up and Operating Capital
The second most common mistake is underestimating how much start up and operating capital your new business will need. This item is always near the top of the list from the SBA and SCORE as a key business mistake. Figuring out your true capital needs requires much more research than just listing your estimated start up costs, like rent or mortgage, utilities, supplies, etc. You need to have a good understanding of how much your product will cost to produce. To know that you must know how many of your product you will be creating, and to know that you need to do the first step: business planning. You can see now how they rely so closely on each other.
Keep in mind, these two items are constantly in flux and they need to be re-evaluated on a regular basis. They should be revisited often in a start up situation to make sure you're on the right track.
Using the skin care example above, if you called around and got some production quotes of $10 per box, you know you're profit would be approximately $15 per box. You can then go back and recalculate how you'll hit the goal of $500,000 net per year. At $15 net, you need to sell just over 33,333 units. If they cost $10 to make, you need at least $333,330 in cost of goods. Take that number, and add it to all the fixed costs you've already quoted, like rent, utilities, insurance, licensing, legal, paper, etc. When looking at operating costs, most business consultants recommend you plan for at least six months of operating costs before your company will turn a profit. However, if in the course of your business planning you determine it will take longer, you will need to be more conservative and account for that in your cost planning.
When you arrive at a number for star-up costs and operating costs (6 months or more) you will then need to make that money available before actually starting the business. Again, it's important to make sure you've got enough of a cushion to carry you through those early days when it's all cost and no profit. If you don't have enough cash to pull off the venture then you need to make a choice. Can you raise the money from other sources or can you lower your operating costs? If the answer to both of those questions is no, the odds of failure will be high. If you can not lower your costs, then you will need to raise money. If you have planned your business properly you will have all the information necessary to put into a basic business plan which can be used to solicit venture capital/start up funding.
Funding can come from any number of sources, including grants, loans, equity, tapping into your savings, etc. The first place to look is your family, or close associates. If you can't raise all that you need from those sources, you need to expand your search into the public arena. There are many sources of funding for businesses that show potential. A business plan is a must, and good experience on the part of the owner/founder helps too. A business consultant, SBA representative, or SCORE professional can help you identify those money sources.
Business Controls and Metrics
Finally, you need to address the third most common, and definitely the most overlooked reason for business failure; a lack of controls or metrics to measure the business operations. What is a metric? A metric is anything you can measure or quantify. There are PhD courses taught on this subject, and careers in things like Six Sigma and LEAN methodology that corporations pay hundreds of thousands of dollars a year for their employees to attend, just to learn how to more accurately track business metrics. The good news is you don't have to get that detailed when you're starting out. You just need a simple way to track the metrics that matter most to your business. Overall return (financial metric) and customer satisfaction (quality metric).
Cash Flow and Return
You should track, as closely as possible, your overall return and cash flow because it is the lifeline of your company. You need to know at any given moment how much is flowing in, how much is flowing out, how much is owed to you, and how much you owe to your creditors. That can be done quite simply with a spreadsheet and some accounting software. You'll be relating the expenses of the business to the income generated to determine the overall return or profitability. This will be the first important measure in where you are in the process of meeting your overall goal.
Customer Satisfaction
Quality is also important, as it determines whether your customers become repeat buyers. Every business wants their customers to be happy so they will go out and recommend that business to their friends and colleagues. You should put a process in place to regularly sample customer feedback on your product or service. Maybe a customer survey or a simple poll. If the feedback is negative you'll gain valuable insight into the changes that need to be made to continue making sales.
Again, doing these two simple steps puts you ahead of the pack. Most business owners would try to keep on selling, not stopping to ask why their customers never return to the store for a second purchase. By comparing your actual operations to your goal, and the progress you've made in attaining that goal you will be able to act from a position of understanding, rather than blindly guessing at why your business is operating the way it is. You;ll be able to move quicker if something does need to change, and you recognize that moment alot sooner than the entrepreneur who doesn't look at metrics. They may not notice it at all, until its too late and they have to shut the doors.
As your company grows, you can add other metrics that relate to cost savings, or increasing value for your customer. You can look at internal processes to make them more efficient and turn out more product for the same price, or cheaper. You can look at your hiring process, your marketing and advertising, or any other business process to make sure they are working correctly and can't be improved.
As you can see, the three most common mistakes can be easily avoided with some proper planning and deep thought on your own personal goals, and that of the business. With basic organizational skills, and an eye for the numbers you should be able to get a handle on the business costs, profits, and return, and be able track them through key business metrics.
If you need help understanding any topics mentioned in this article, or you would like to see a few templates for the processes mentioned herein, give us a call or send us a note and we'd be happy to answer any questions you might have.
As always, Cornerstone takes pride in helping entrepreneurs start on their way to achieving their business goals and dreams, and if there is a way we can help you too, we welcome that opportunity.
Good luck.
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