Nine Financial Mistakes That Can Kill Your Business

By Larry Willeman, WIlleman Strategy Partners, Inc.

Some companies fail because they have the wrong product for their target market. Others fail because they have the wrong people running the company. But even with reasonably good products and a competent management team, there are a number of financial mistakes that can kill a company. During the last 20+ years I’ve seen tremendous successes and utter failures… and everything in between. The failures due to financial mistakes fit into the following broad categories.

1. Forgetting that cash-in versus cash-out is THE most important financial measure. Most companies put their emphasis on profitability. The dot-com bust proved once again that profitability does matter, but there is a saying that “cash is king.” My assertion is that managing cash flow is THE most important financial measure in any growing (or stagnating) business. Knowing what cash is coming in versus the amount required to go out not only helps you understand what amount can be re-invested in the business but in many cases determines whether a company will survive. Not all cash must come from operations. Investments, both debt and equity, can provide intermediate cash to run the business but it is critical to know well in advance what the cash needs will be to find the best source of funds. Any experienced investor will require a clear indication of what the investment will be used for and whether it will be enough to take the company to positive operating cash flow or at least to a stage where additional funding will be available.
   
   If your company requires large investments in plant and equipment or inventory, to grow it is possible that success can kill your company. Here is a hypothetical situation similar to what has happened at many technology companies: a high-technology equipment manufacturer’s product generates substantial demand when it is released. Customer orders far exceed available supply. The manufacturer orders a substantial supply of raw materials and various components to meet both unfulfilled orders and a new higher forecast of new orders. The raw materials and components are added to inventory. Due to the amount of production time and possibly competition, customers cancel existing orders. The company gets a reputation for not being able to deliver customer orders. New customer orders drop off. The company is holding inventory for which it has no orders and which is now becoming obsolete. Suppliers must be paid or they won’t ship components for any other products. The supplier won’t take the inventory back without a large restocking fee, or won’t take it back at all because it is unique to that customer or is obsolete. This type of situation has resulted in millions of dollars of inventory write-offs for what were otherwise successful product launches. Having financial resources available, the ability to identify a variety of potential scenarios, and strong relationships with key vendors can get you through these types of situations. The ability to forecast cash flow and manage the key “levers” that affect cash flow will have a lot to do with whether the financial resources are available when needed.

2. Not paying your payroll taxes. When companies run into cash-flow problems, they often start prioritizing what payments they make. And it’s easy to think that paying the IRS is less important than paying an important vendor. Often payroll taxes are a substantial amount of money. If you get behind, it becomes increasingly difficult to get caught up. And the IRS is very aggressive about making sure that you don’t treat tax payments as discretionary.
   
   During the late 1990s, a firm was doing what was described as a “roll-up,” buying smaller companies to create one larger, stronger company that could potentially do a substantial initial public offering. The company ran into trouble and was struggling to survive, as did many companies around the 2000-01 stock-market decline and related sour economy. The company stopped paying payroll taxes as well as other vendors. Not only did the company go out of business but the chief operating officer (COO) of the parent company was personally sued by the IRS for payment. The IRS often will “break the corporate shield” and seek payment from the individuals who made the decision not to pay the taxes. The COO’s personal finances were decimated. Several years later, he was still trying to negotiate a settlement for several hundred thousand dollars owed to the IRS. All this was because a company his company acquired, in which he had never set foot, did not pay payroll taxes and the IRS determined that he was one of the people responsible for making the decision not to pay.
   
   In one of my past roles, I was part of a company that acquired a small, struggling company. IRS rules required that the small company change to making more frequent deposits of payroll taxes collected. The company did not make the change right away. The IRS levied a fine that was about 15% of the amount due (i.e., about $8,000) for being a couple weeks late. After a substantial number of conversations and a full day of training (or was it punishment?) the IRS did rescind the fine. We were very fortunate. What all this means is make sure your company pays any payroll taxes due. The IRS doesn’t have a sense of humor and can make your life hell.

3. Pricing. Many books and articles have been written solely on the subject of pricing. The reason is that pricing is critical to the success of any business. If you sell the product for too little, your company may not be able to cover all its costs or at least will leave potential profits on the table. If the price is too high, there may not be any sales. Also, the price of your product communicates information to current and potential customers, and often infers the quality and amount of value the customer can expect. If your product/service is a commodity (the same or similar to products/services that can easily be purchased from other sources) then you will have very little ability to price above the competition without adding substantial value in other ways (i.e., additional services, expertise, “one-stop shopping,” etc,). In cases where your product/services are unique (a.k.a. highly differentiated) then there is the potential to premium price if the unique value can be communicated to, and appreciated by, the customer.
   
   One fairly new company that provided training classes had created and published a new course list. After they began registering students, the owners figured out that even if every training class was filled completely, they would still lose money. A little bit of financial modeling ahead of time would have been a big help.
   
   Pricing is more than just setting an asking price (a.k.a. list price, retail price, MSRP, etc.) for the product or service. Pricing also includes discounting practices and the “effective” price.
   
   Understanding your customers’ views and culture are critical to setting the asking price. For example, while on an extended assignment in Singapore, I often dealt with street vendors. The cultural norm is that substantial negotiation is part of every transaction. In nearly every case the item was ultimately purchased for at least one-third less than the asking price and often less than half of the original price. If you are a vendor working with customers with these expectations, and you set a price that would not allow you to give substantial discounts, you will not be successful. The electronic design automation software industry is another industry where customers have learned to expect substantial discounts. You have to get inside the heads of your potential customers and understand how they expect to do business. Of course, this applies to many non-pricing issues as well.
   
   You also have to be careful of what I call the “effective price.” In many businesses, inducements are given to encourage the customer to buy. Credit card companies offer frequent flyer miles. Retailers give free shipping and some vendors even offer to customize products. Make sure these inducements are well understood and are based on conscious choices about what is good for the company. The inducements should NEVER be offered at the sole discretion of a salesperson focused on a current commission. More than one company has failed due to these types of problems.

4. Making major expense commitments before revenues materialize or funding is secured. One company president was certain that he would be finalizing a contract to take over another company’s customer service organization. Needing facilities for the team, the company executed a lease for office space costing $30,000 per month. The contract for the service organization was never finalized. The company that signed the lease is out of business.
   
   Most entrepreneurs have an almost irrational belief that they can overcome all odds to be successful. This is close to a requirement for success. However, don’t let your confidence overwhelm your rational thought process. Make sure you know when the decision you are making can kill the company if things don’t go your way. Many companies believe customers will beat a path to their door as soon as they make their product or service available. While you must have a plan of action if this does occur, minimize the financial commitments that require instant customer acceptance for you to pay for them (and stay in business).

5. Having the wrong person “handle the books.” A president of a company realized he didn’t have the information he needed to run the business. The company’s controller was a woman everyone loved and who had been with the company for many years. The combination of the controller’s minimal formal financial training and the president’s tendency to be “hands off” on financial details proved disastrous. Closer review showed that not only was the president not getting the information he needed, but that the controller had been embezzling money. Unfortunately, the damage had been done. For this and other reasons (see #4 above) the company is no longer in business. Make sure you always have more than one person who has an intimate understanding of your company’s financials. Make a clear, conscious choice about who can sign checks and approve company resource commitments.
   
   Fraud is not nearly as common as the press would make you think, but you do need to have proper controls. What is very common is that companies get little or no useful financial information to run their companies. Some companies struggle to get accurate, basic historical financial statements within a couple weeks after the end of a month or quarter. But actual financial statements only show you what has already occurred. What companies really need are early warning signals that allow the company to take corrective actions before it’s too late, such as rolling profit and loss forecasts, order forecasts, cash flow projections, resource utilization forecasts, etc. If you haven’t modeled the financials, then you could do exactly what your company is trying to do and the company could still fail.
   
   The people handling the financials will see information that no one else will see or be aware of, unless the financial folks understand the importance of it. They also need to be highly effective at communicating issues to the people within the company that can and will take needed actions.

6. Taking money from investors or adding partners who have inconsistent objectives. The other day, I heard a venture capitalist say that the average VC investment lasts longer than the average marriage… and you can’t divorce your investors. Every investor has certain expectations. Some expect cash return on their investment within a few years. Some expect to be involved in the management of the business. Some will require control. The list of ways a relationship with an investor can go bad is too long to list here. But as a business owner you need to make sure you know what your prospective investors’ objectives and criteria for success are, before you take their money.
   
   During difficult times, I’ve heard business owners say they would basically take money from anyone who was willing to give it to them. Unfortunately, all money comes with significant strings attached. Whether it comes from your mother-in-law, your bank, a venture capital fund… every one of them has a reason for making that investment and what they expect in return can come back to haunt you for years and years.
   
   Quite often, growing companies require funds from multiple sources. The type of investors or company ownership structure can make it impossible for other types of investors to participate. You could end up with investors who are relatives who grill you regularly about when will they get their money back. So, give it some serious thought before you sign the paperwork and cash the check.

7. Taking too much money out of the business. You could actually look at this section as a continuation of section 1 above. Most business owners and founders intend to enjoy the fruits of their labor at some point, which is perfectly reasonable. The problem comes when the business owners have not studied in enough depth the cash needs of the business before taking cash out. The cash balances may be fine for a “business as usual” scenario but not enough to cover a sudden drop-off of customer orders. In some industries it’s “grow or die.” Your industry could consolidate and require the critical mass of a larger player. Will there be significant costs of upgrading older equipment or increasing the size of your facilities? Make sure you consider a variety of scenarios and understand the financial resources needed to reach your company’s objectives… before taking significant amounts of money out of the business.

8. Not taking appropriate risks. Taking calculated risks is central to every business success. One sure way to lose in business is to not place any bets. On the other hand, reckless decision-making will have about the same odds of succeeding (or worse) as the odds of consistently winning in Vegas.
   
   Risk aversion often shows up as an inability to make decisions or the unwillingness to spend even small amounts of money. Business owners and managers sometimes spend far too much time trying to save insignificant amounts of money. I’ve seen small businesses spend hours upgrading old PCs instead of buying new ones. More often than not, that time would have been far better spent focused on finding paying customers and delivering products and services.
   
   Hiring employees, investing in research and development, spending on marketing programs are all risks. Whether they are calculated risks or recklessness depends on how these decisions are made. No one is correct on 100% of their decisions (unless they don’t make any). Keep an eye on your “batting percentage.” Some decisions can make or break your company and will require substantial analysis and a higher degree of caution. Other decisions are routine and a perfect solution is not required.
   
   Both severe risk aversion and recklessness are likely to be fatal. Consider the financial and non-financial implications of your decisions carefully.

9. Not investing enough in marketing and sales. One of the risks a company must take is investing in marketing and sales. Of course, if you are deep into developing your product and do not yet have anything available to market, it may be too early to invest substantial amounts into marketing and sales. But if you are a going concern, you must invest the appropriate amount of time, energy and dollars into identifying and communicating with potential customers, and ultimately converting them into paying customers. This process is one of the most important, if not THE most important, process in any company. Unfortunately, there are endless ways to waste money on marketing. It is not always clear which marketing efforts generate leads or results. Investments in selling activities are not any easier to figure out and sales folks can be high-maintenance, temperamental folks (especially when they’re not selling much).
   
   There are numerous examples where better products and technology have lost out to companies that were more effective at marketing and sales. Many of these companies go on to dominate their markets and with the financial success, they are able to out-invest their rivals, which allows them to close the product gap and even surpass the quality of their competitors’ products (Microsoft and Apple are the most noted examples, but there are many others). So whatever industry or style of company, you must perfect, refine and improve whatever process you use to acquire customers. This can be improving a web site for better conversion rates, developing a highly specialized technical sales force or a building and strengthening relationships with key customers. Cost reduction can only go so far to improve a company’s results. Whatever the financial condition of your company, the process of acquiring customers must be strong or your company will not be.

Many companies have learned these lessons the hard way and some have not survived to tell the stories. Use your instincts, study your situation and get guidance from your trusted advisors.

About the author
Larry Willeman is a 20-plus year veteran of the Portland-area high technology industry, working for companies such as Mentor Graphics, Fluence Technology, Credence Systems, Photon Kinetics and Metheus Corporation. He founded Willeman Strategy Partners, Inc. in 2002 to help small and growing companies achieve their business objectives. Larry has helped numerous companies refine business strategies, improve decision making, secure funding and increase the effectiveness of financial operations. He can be reached at larry@willemansp.com. Information about Willeman Strategy Partners, Inc. can be found at http://willemansp.com.