The Number One Reason Businesses Fail

A businessman is using his computer to properly track and manage the cash flow of his business.

Even with the highest quality products and most compelling ad campaigns, businesses run the risk of financial difficulties and even bankruptcy if they don’t effectively manage their finances. In fact, a huge percentage of businesses will fail within their first 5 years in operation.

Why do so many new businesses fail?

Of the 400,000 businesses opened each year, half will fail in their first five years of operation. The most prevalent reason for business failure is poor cash flow management. In fact, 82% of businesses that fail claim this as one of the reasons.

Cash flow management entails forecasting revenues and expenses, while determining how to best allocate cash resources. For a business to be successful in managing their cash flows, they must accurately predict future cash inflows and outflows. These predictions are easier to make when the economy is stable, but as evidenced by the recent pandemic, market conditions can change quickly. When market conditions turn negative, businesses often rely on their cash reserves to survive.

Business Cash Flow Management During the Pandemic

The Federal Reserve estimates that 40% of businesses suspended operations during the pandemic, either temporarily or permanently. During these closures, most businesses were unable to make in-person sales. Naturally, the loss of revenue caused many businesses to struggle. As such, chapter 11 bankruptcies, the most common type of business bankruptcy, were up more than 18% in 2020 – despite legislation enacted to help businesses survive the pandemic.

At the onset of the pandemic, the average startup only had enough cash reserves to last two weeks. While widespread data is difficult to obtain in real time, a snapshot of the pandemic’s effects on business can be seen through the Federal Reserve’s Small Business Credit Survey. This data shows that more businesses went into debt during the pandemic, due in part to a shortage of cash reserves.

Currently, 79% of employer firms have debt outstanding, up from 71% in 2019. Relying on debt to maintain operations during a crisis can be unreliable. Often, the funds needed outweigh a business’ borrowing ability. For those businesses that applied for loans in 2020, only 37% of applicants received all the financing they sought, down from 51% in 2019.

When loans are not available, business owners must turn to their own savings to keep their business afloat.  A staggering 62% of businesses surveyed used personal funds to address their financial challenges in 2020.

How Businesses Can Prepare for a Crisis

Businesses should plan for a crisis by maintaining sufficient cash reserves. These reserves should be large enough to cover operating expenses for several months in the case of decreased revenue, but not so large that they stifle the company’s ability to invest. A portion of cash reserves should be earmarked as emergency cash – to plan for the unexpected. These funds should be sufficient to allow the company to stay afloat for a few months in the event of lost revenue. Most importantly, the emergency funds should be kept in a safe, liquid, and easily accessible account so they are available when needed.

FDIC and NCUA insurance offer the highest level of protection for business cash, but there are limits to the amount they cover. In 2021, the FDIC / NCUA limit is $250k per account ownership category at member institutions. For businesses with cash holdings that exceed this limit, our company, the American Deposit Management Co. [ADM] is able to provide access to extended FDIC / NCUA coverage for all of a business’ cash. By leveraging our proprietary financial technology, or fintech for short, cash managers can earn competitive returns on their cash reserves, while maintaining safety and liquidity.

Get Safety and Nationally Competitive Returns on Cash Reserves with AMMA™

With our American Money Market Account™ [AMMA™], businesses can rest assured that cash holdings are covered by the highest level of deposit protection. In addition, businesses that take advantage of AMMA™ can access competitive interest rates, without traditional geographic limitations. With AMMA™, businesses receive safety and nationally competitive returns for their cash, while enjoying next business day liquidity.

At ADM, we take the work of cash management off your plate. If you are looking to develop a cash management plan or reduce the work required to manage your cash, don’t hesitate to contact us. Our team is our secret sauce and you will understand that when you give us a call.