Vernon Budinger, CFA, CAIA, QuickBooks ProAdvisor
October 15, 2022
Neural Profit Engines has developed the “Neural CFO” © business track to guide businesses through rough times. The motivating factor is that all businesses will face an event or a series of events that will threaten their viability sometime during the life of the business. New business owners need to understand that companies that thrive over decades may not be the company with the best product; however, they had plans and skills to survive unnecessary pandemics, economic turmoil, or disruptive new technologies.
U.S. Bureau of Labor Statistics data confirms that, on average, 20% of new businesses will fail after 1 year (orange arrow) and that 50% of businesses fail in their first five years (blue arrow).
Figure 1: Business Survival by Year Started
The source of this information is the U.S. Bureau of Labor Statistics Business Employment Dynamics Database, which identifies new business startups by the year that they were formed and tracks them over their lifetime based on this information. This provides incredibly useful information about business success versus failure. The first graph tracks business success by cohort. The second graph tracks each year’s cohort over time.
While the probability of a new business succeeding ramped up after 2013/2014, the overall time series has been remarkably stable (see Figure 2). This suggests that it is not the business environment that determines the success or failure of a small business, but the internal processes that new businesses follow seem to be flawed. In other words, new businesses don’t learn from previous failures of business owners and follow the same bad practices year after year even though the business world generally knows that these practices lead to failure. This is something that is theoretically unacceptable in modern capitalist society.
Figure 2: Cohort transition over time
New Business Fail Because They Repeat Bad Habits
A Google search finds hundreds of articles that list thousands of reasons that most businesses fail. Here is a condensed list.
1) No vision: Laura Cowan finds that most successful business owners have a clear vision for the future of their business and failing business owners don’t.
2) Bad management skills: small business owners must take on more responsibilities than the owners of more established companies that can hire managers for specific areas such as finance and human resources. As a result, new business owners often zig when they should zag or cannot deal with a critical issue because they are burdened with a special project for their company.
3) No niche: Many businesses choose the wrong niche or no niche for their target market and thus do not deliver the product that potential customers want.
4) No business plan: In reality, #1, #2, #3, and #5 are the results of poor planning. An effective business plan helps the founder evaluate the market opportunities, understand the need that the business’s products will satisfy, and establish a route for launching the business and building a strong clientele.
5) Insufficient funding – Small business owners often finance their business with personal savings and don’t anticipate how cruel the business world can be when business turns bad, or complications develop.
6) New business owners often underestimate expenses, especially in today’s inflationary environment.
7) Low-profit margins: Low profit margins are a killer, especially deadly during inflationary periods. Many firms do not even know their profit margins.
8) No marketing plan: Business owners who build a business plan usually create a marketing plan. Furthermore, if you don’t have a marketing plan, you probably do not know what market niche needs your products.
9) No action: Cowan feels that many new business owners fail to act because they try to be perfectionists. However, many new owners do not have the information network set up and fail to see the signs of trouble early enough. In critical situations, critical events unfold rapidly and they demand quick action.
10) No commitment to learning
11) No follow-up: Business owners are perceived as inattentive or unprofessional because they fail to follow through on promises.
12) No consistency
Sources:
Laura Cowan: Eight Common Reasons Small Businesses Fail (forbes.com)
George Meszaros: 10 Unforgivable Reasons Why Small Businesses Fail – Business Tips & Advice (successharbor.com)
Melissa Horton: The 4 Most Common Reasons a Small Business Fails (investopedia.com)
NPE Evaluation
While these authors are all correct, further analysis reveals that there are only a few core factors that drive business success. One tool for understanding the REAL problem is the “5 Whys” method; ask the question “Why?” at least five times and look at that answer or ask until the same answer repeats.
For instance, “Why didn’t a business have enough cash to survive?” The answer is most likely that the company did not put together a budget and financial forecast. Then ask, “Why didn’t the business create a budget with a financial forecast when it is part of a strong business plan?” The answer will most likely be that the business did not put together a plan. Then ask, “Why didn’t business put together a plan?” The most likely answer is that the business owner did not have the discipline to write a plan. Finally, “Why didn’t the owner have the discipline to write a plan?”. The answer is that the owner was not the right type of person to start a business – this is the reason the business failed.
The same answer generally results from going through the same process when asking “Why?” about marketing plans, market niche or market served, creating a product that did not fill customer needs, bad management style, and underestimating expenses. These items are all part of a strong plan that comes from the company’s vision for satisfying the needs of the public.
The “5 Whys” process leads to a shorter list of reasons for business failure:
1) The new business owner is not a good manager because they did not have the discipline needed to organize and run a business.
2) The new business owner did not write a good plan to serve as a roadmap to deal with unexpected problems because they were not familiar with the components of a good business plan.
3) The new business owner faced a perfect storm of critical events that dealt a death blow to the company.
The solution to #1 and #2 is obvious: develop the skills and discipline necessary to run a business – the subject for upcoming papers. However, factor #3 is a tough one. Navy SEAL training has an exercise to deal with this; it’s called the “sugar cookie.” Recruits are targeted during training to go through the “sugar cookie” drill. The drill instructor inspects the recruit’s uniforms and will pick a few for failing inspection, even though their uniforms are perfect. The selected recruits then need to run to the ocean, dive into the surf and then roll in the sand. They must then work the rest of the day in a sand-coated uniform – which looks like a sugar cookie. The exercise is designed to teach SEAL trainees that war is unpredictable (as is business). You can do everything perfectly and still fail. You can’t spend time fixed on the past and all the what ifs. You must focus on the future and move forward.
This is where the plan is essential. The plan and the plan’s budget establishes performance targets and identifies the business performance necessary for success and, as a result, failure. The entrepreneur with a plan will be able to pivot and shut down more quickly. In the words of John Calvin Maxwell, American author, speaker, and pastor, “Fail early, fail often, but fail forward.”
Neural Profit Engines offers planning and budgeting services. Our experience has been honed through years of investigative investing; reviewing plans, building plans, calculating the budget that meets the plan’s goals, and implementing the tracking needed to accomplish the plan’s objectives. Use this link to access our website and schedule a free consultation.
Vernon Budinger
Owner, Neural Profit Engines
vernon@neuralprofitengines.com
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