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financially sound small business

5 Traits of a Financially Sound Small Business

When entrepreneurs piece together a vision of their future business, they often think big and exciting. Rampant growth. New product lines. A sleek, modern office with amenities for their tireless employees.

But none of that will last unless your small business is financially sound, too.

A small business is rarely going to be flush with cash immediately. It will likely take a few years (or more) before you’re “comfortable.” However, if you operate your company with a focus on being economically viable every step of the way, you’ll boost one trait that many pie-in-the-sky visionaries overlook: resiliency.

Scintillating? Of course not. But economies cycle. Recessions can and do happen, and at some point, you’ll have to be able to survive one. Companies that manage their finances and operations the right way are more likely to keep ticking.

To help give you a blueprint, here are a few traits of a financially sound small business.

They Have a Clear Path to Profitability: Most conversations about growth center around revenues – simply how much money you can bring into the business. But when businesses eventually go bankrupt, it’s typically not because of a lack of revenues – it’s from a lack of profits. In a perfect world, you operate a business that can generate profits at any scale. However, some businesses simply need scale to get there. That’s OK, but if that’s the case, understand that VCs and other sources of funding will want to see how they eventually achieve a return on their investment. If your plan shows an undisciplined approach to spending, they’ll know that promises of profits are just empty words.

They Scale as They Need, Not Just Because: This trait is tied to the first. “Scale” has become something of an Iowa ballfield in business: If you scale up, profits will come. It’s rooted in economic sense, of course: A costly system to mass-produce dolls will lose you money if you have two customers, but make you profits if you have 20,000. But the emphasis on scale sometimes blinds entrepreneurs to the point where they think any scale is good, at almost any costs – justified by an eventual payday somewhere out in the ether. But that’s a quick way to drain your cash and put you into debt. Instead, scale as you need it. For instance, before you expand from your one-man shop, determine whether you’re even ready for your first employee. This includes figuring out whether you can generate more revenues from a new hire.

They Hire Intelligently: There’s no inherent benefit to the simple act of adding an employee to the payroll. If you do it right, you’ll get a return many times more than your investment on that individual. Sometimes, a hiring manager wonders if they’ve committed subtraction by addition because a new employee works out so poorly. Great businesses are able to identify not just the talent they need right at that moment, but the development potential for talent that they might need down the road. This is especially vital for small businesses, who usually don’t have the pockets to lure in experienced hands, and instead must “grow through the draft.”

Low Debt Ratios: You’ll note that we’re not saying “no” debt. Debt can just as easily be your friend as it can be your foe. It allows you to make necessary purchases to achieve growth that you likely couldn’t cover with cash on hand. But typically, financially sound businesses are going to have low debt-to-equity or debt-to-asset ratios. The idea here is simple. The more debt you accumulate, the more you eventually have to pay back – and the more you’ll be paying in regular interest rates, hindering your ability to accumulate the cash necessary to pay off the principal.

New and Old Customers: You’ll sometimes hear the question, “Should I spend my money trying to accumulate new customers or keep existing ones?” The answer? “Yes.” Customer acquisition is absolutely more expensive than customer retention – by as much as 5x. But most small companies simply don’t have enough customers to make merely hanging on to them a viable business strategy – certainly not if they want to pursue any growth whatsoever. The flip side is that you’ll bleed out if you pump all of your money into customer acquisition. Financially sound small businesses know that success comes via a happy medium of trying to pick up some customers while also trying to keep them loyal and spending more.

Like most advice, tips on becoming more financially conservative are easy to read but more difficult to execute. But McManamon & Co. can help. We’re an accounting and business-services firm that addresses a wide range of small business needs, many of which work toward responsibly growing or protecting your company. For instance, our accounting experts can keep you on top of your company’s finances, while our consulting services include strategizing, recruiting corporate bankers and tax planning.

Give us a call at440.892.9088 or contact us online to start taking the right steps toward being one of the financially sound small businesses that others look up to.

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