Every business faces red flags, no matter its size or profitability status; small businesses are no exception. Knowing and identifying red flags that threaten your business is crucial. Ignoring red flags is like walking onto a train track and ignoring an oncoming train. Facing away from the train or ignoring it does not lessen the chances of being hit by it. The same conclusion applies to your business. If you are going to succeed, you cannot ignore your business’s warning signs. Four significant warning signs small businesses face are discussed briefly below.
No Budget or Projections
A business that operates without a budget or projections is akin to a house without walls. The lack of boundaries creates tendencies for overspending, underpricing of services and products, and making inaccurate operational decisions. To avoid these and other red flags, the business should have an annual budget in place. A budget provides a business with financial direction over a short period, typically 12 months. Projections are similar to a budget, but are for a shorter period, usually a month or quarter, and can be adjusted over time. Putting a sound budget together can be time-consuming, but the benefits reaped from it make it worthwhile.
No Regular Review of Financial Statements
A second red flag that small business owners often face is dismissing the review of their financial statements. Business owners are sometimes intimidated by financial reports, finding them too complex to understand or struggling to comprehend the story the numbers tell about the business’s performance. Remember that ignoring a business problem, whether by not looking at the statements or not raising questions, does not make the problem go away. Likewise, running the financial reports is the accountant’s job, but understanding them is your job. One sign of a good CPA or accountant is that no matter how complex a report is, she can decipher its story in a simplified way that anyone can understand. Financial statements should be reviewed monthly with no exceptions. The sooner an issue is identified, the quicker it can be addressed.
Improper Posting of Transactions
A common error I see with new clients who are non-accountants and either handle their business’s accounting or have an accountant who doesn’t thoroughly analyze the books is that transactions are posted to incorrect accounts. For example, a rent expense is posted to the supplies account, or a payroll processing fees expense is posted to payroll liabilities. I recall an incident where a $50,000 sale had been posted to accrued expenses instead of the sales account. When mispostings occur, they inflate or deflate the various categories – assets, liabilities, income, or expenses – of a business. This leads to unreliable financial data and improper tax reporting, whether estimated or annual. If you are not sure where a transaction belongs, seek an accountant’s help rather than guessing.
High Debt Ratio
A fourth red flag impacting businesses is having a high debt ratio without a plan to reduce it. A debt ratio compares the total debt owed by a business to its current assets – typically, cash and accounts receivable. The ratio measures the ability of a business to pay off its debt in the short term. If the ratio is higher than 0.5, it should raise concern. Having a plan in place to reduce or pay off the debt is crucial. Sometimes this means aggressively collecting on outstanding payments due or limiting cash outflow by making fewer purchases of inventory or supplies.
Being able to avoid these red flags is key to your business operating profitably. If your business needs help with any of these four areas, reach out to our offices, and we will be happy to assist you.
DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.
