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The Rise and Fall of Small Businesses: It’s Often a Matter of Business Credit

October 30, 2013 by Gary Stockton

Starting a business often is the culmination of a dream to bring a brilliant new idea to market, to become financially secure or simply to be one’s own boss. Unfortunately, many businesses go on to fail without the owners fully comprehending why. According to a recent Infographic from .docstoc, seven out of ten new businesses survive only two years, half at least five years, a third last at least ten years and a quarter stay in business fifteen years or more.

The U.S. Small Business Administration is uniquely positioned to identify the biggest obstacles entrepreneurs face. To help small business owners understand the reasons enterprises like theirs fail, the organization cites the conclusions of business authors Michael Ames and Gustav Berle.

According to the authors, the list of the most common reasons for small business failures is as follows:

1. Lack of experience

2. Insufficient capital (money)

3. Poor location

4. Poor inventory management

5. Over-investment in fixed assets

6. Poor credit arrangements

7. Personal use of business funds

8. Unexpected growth

9. Competition

10. Low sales

Of the list, at least seven can be linked to the use or misuse of business credit. So let’s dive in and examine the ten reasons a business will fail.

Lack of experience - There’s an old expression that suggests success comes from “doing what you do well.” In a business setting, that means entrepreneurs must have the experience needed to anticipate and handle the challenges their company faces in its initial stages of growth. Conversely, a lack of experience with the products or services, the nuances of the market, and other essential factors may doom a business to failure.

Insufficient capital - That familiar old saying, cash is king, couldn't be more appropriate these days with tightened lending policies making it harder to obtain a business loan and the prospect of getting payment extensions less likely. Even if its financial statements show a profit, a business won’t be around long if capital expenditures or receivable collections are siphoning away cash. To survive, businesses must focus on cash flow generation to be properly capitalized with enough in reserves to weather whatever comes.

Poor location - Just as in the residential real estate industry, location, location, location are the three most important considerations when locating a business. Especially when establishing a brick and mortar business, it’s essential to understand where the targeted customers work or live, traffic conditions and accessibility to the business, parking considerations, where the competitors are located, and even the condition of the building.

Poor inventory management – Businesses that are fearful of running low on essential items, whether they be finished products or components, may spend too much on inventory, draining their working capital and eroding profits. It’s better to make projections regarding how much is needed and when based upon experience. Tying a line of credit to these purchases frees working capital for other needs.

Over-investment in fixed assets - Starting a business requires an investment of capital in fixed assets like manufacturing equipment. It’s best to evaluate the usefulness and the necessity of these assets before purchasing them. Spending too much on fixed assets at the beginning of the business may result insufficient cash flows to keep the business afloat.

Poor credit arrangements - A business may succeed or fail depending upon the credit terms it offers to its customers and the terms it receives from its suppliers. It’s critical for a business to make sure that its credit terms are clear and easy to understand. Giving customers too much time to pay their bills can be disastrous because of the affect it has on cash flow. Many owners of small businesses don’t understand that it’s important to keep tabs on their business credit score right along with focusing on sales, costs, staff and marketing. Lenders, suppliers, potential business partners and many others who may play a critical role in the success of enterprise can view its business credit report and obtain its business credit score for any reason whatsoever, unlike seeing the information in a personal credit report.

Personal use of business funds - Many small business owners use personal credit to run their business, putting themselves at risk if their businesses are ever in trouble. Conversely, some business owners use their business credit card or checking account to cover personal expenses. Particularly if a business is an LLC, corporation, or partnership, the owners are shielded from personal liability for things that could happen in the business. The legal entity separates the person and the business, so if the company is sued, the owner is protected from loss. That protection goes away if the owner comingles business and personal financial transactions.

Unexpected growth - Growing slowly but steadily is always preferable to accelerating from zero to 100, so to speak, in a hurry. Going after all of the business that presents itself drains cash and actually reduces overall profitability. Ramping up in a hurry may result in incurring significant up-front costs to finance inventories and meet customer demand. Going after all of it also causes businesses to be less selective about with whom it does business, which in turn drains profits and runs up credit obligations.

Competition - Competition creates more choices for consumers, study your competitors, look for weaknesses, be mindful that your competitors are doing the same with you. Take the high road to success, trashing the competition creates negative energy which could be better spent creating a great marketing campaign. Using business credit wisely is one of the best ways to succeed in a competitive marketplace.

Low Sales - Sales is the ultimate measure of success for most businesses. Low sales can result from having inferior products or services, a lack of understanding of buying trends, misreading the competition, overpricing goods and services, or employing and keeping a sales force that is not performing at acceptable levels simply cannot be sustained over time. Business owners should always be ready to make a course correction.

While there is no guarantee of business success, the likelihood of becoming successful increases significantly when owners plan strategically, implement carefully and use business credit wisely.

For more information about Experian’s advanced business-to-business products and services, visit www.experian.com/b2b.

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