According to a study conducted for the Kansas City, Missouri-based Ewing Marion Kauffman Foundation, the high cost of credit card debt can quickly drag down growth at a young firm and increase the chance that it will fail in its first three years. Yet small-business owners are still relying on plastic to start a business or fund an existing operation because other sources of money have dried up.
The Financial Death Spiral
Consider this, for every $1,000 in unpaid credit card debt, a start-up business increases the probability that it will close by 2.2% on average compared with having no such debt, economics researcher Robert H. Scott said in an August 2009 report.
Almost 6 out of 10, or 57.9%, of the nearly 5,000 firms in the study used credit card debt to get started. The report looked at credit card use by the businesses in 2004, the year they all got going, through 2006.
“Relying on credit card debt is very expensive and makes these businesses financially unstable,” said Scott, assistant professor of economics and finance at the Leon Hess School of Business at Monmouth University in New Jersey.
In an August 18, 2009 Los Angeles Times story, it was suggested that the negative effect of using plastic to finance a new business’s operations is probably greater today because credit card interest rates and fees have climbed dramatically while credit limits have been chopped. Even mainstream card companies are charging rates of 30% or more in some cases.
Stop Spinning and Create a Clear Financial Picture
In a 2012 story in the Globe & Mail, Mark MacLeod, a partner at the venture capital firm Real Ventures, said many entrepreneurs go wrong in their fundraising strategies by failing to understand the differing needs of lenders and investors.
Proper planning and developing financial structures to allow lenders and funders to evaluate your business based on the measures they need and will help many small business owners and business start-ups avoid these financial icebergs and death spirals.
Make a Financial Checklist
Providing a funder with a clear financial picture means having the following items available and up to date;
Financial Statements – an overview of the Balance Sheet, Income Statement, and Statement of Cash Flows, along with a brief summary of the types of financial statement presentations that are available.
- Financial Goals and Ratio Analysis – analysis of the six key indicators of your corporate financial health, including ratio analysis.
- Financial Projections – an overview of pro forma Balance Sheet, Income, and Cash Flow Statements that forecast anticipated financial performance in the future.
- Managing ‘Cash Drivers’ – working capital and cash cycles.
- Break-even Analysis – relationship between revenue and fixed/variable costs.
- Capital Budgeting – review of longer term investment decisions.
The financial health of a company is the crucial component of the business’s survival and success. Without a clear picture, and proper planning, owners work themselves into a corner, eventually having nothing but plastic credit to cling to.
Do you have a clear picture of your financial state or are you avoiding the discipline of financial planning for your business?
Business Diagnostics is a best-selling business text book, written to help business owners and managers recognize and avoid scenarios such as this. Co-author Rich Mimick and Terry Rachwalski along with Mike Thompson wrote Business Diagnostics, 3rd Edition to provide a pragmatic framework for sizing up the health of a company and proper financing and planning strategies.