Why do SMEs get into Financial Difficulty?


14th December 2020
For any small to medium sized business, becoming and remaining financially solvent, is the name of the game. To reach and maintain that position can be harder than it might appear!   

Sadly, many SMEs never actually manage to turn a profit. For those that do, past performance is no guarantee of future success. There is never room for complacency – whether a company is operating in a highly competitive market or in a cosy little niche, where rival operators may be scarce on the ground.  

The majority of business failures are likely to happen in the first year, so if you have been trading for longer than that, your chances of survival immediately improve.  Nevertheless, recent statistics from the Office of National Statistics reveal that around 56% of start-ups fail before their fifth year. Keeping the dream alive is not as easy as it looks.   

For owner managed businesses especially, understanding why the venture isn’t making any money or isn’t as profitable as it once used to be, can often be hard to fathom. Reversing the fortunes of a failing enterprise is often a tough ask – particularly if the real reasons for lack of success are unpalatable to acknowledge. It could mean personal pride taking a dent, with personal loyalties coming under real strain.   

So why is it that SMEs encounter financial difficulty? Here's a round-up of the most likely causes.    

Failing to plan is planning to fail 
A comprehensive business plan is essential. If the senior management aren’t working towards a clear plan – that’s not good. The back-of-a-fag packet approach to strategy is never going to work.  And any manager taking this line of attack is likely to be a poor one – in every sense! 

What are the goals of the business?  What is the size of the market? What are the price points for the products or services being sold? Is this in line with industry levels? What competition is out there?  What are the financial projections for the first 3 to 5 years of trading? How much money has been set aside for recruitment of staff and marketing?  All key questions that need answering if you are to build a bona fide business. 

Companies that run onto the rocks are often those that haven’t put together a coherent plan or have been slow to react to changes to market sentiment or economic circumstances. 

Money’s too tight to mention 
Access to capital can be a festering issue for many SMEs. If credit lines are tight or overdraft facilities incompatible with business cash flow, this can drain the life out of a business. A company that goes bust because it is forever running at a loss, might have been able to survive with access to the right levels of capital in the first place. 

Connected to all of this are banking relationships. Is the business aligned with an accommodating and supportive lender?   

As with the business plan and cash flow forecasts, at what point was the business capable of generating a profit – how much time was this meant to take? And had any contingency plans been put in place in the event of unforeseen difficulties or trading downturns? 

Over Ambition  
Running a successful business doesn’t always mean that you should be looking for every opportunity to expand – and certainly not too quickly.  An SME can become, or be, too big – even though that may sound counter-intuitive to an ambitious and enthusiastic business owner. Whilst it is important not to be complacent and stagnate, growing a successful and sustainable business is not something that should be rushed. Taking on extra staff too quickly can be disastrous. The time to scale-up is when it’s becoming challenging to meet customer deadlines and your current employees are being overloaded with work - not beforehand. Otherwise, you will simply be adding headcount to the payroll and eating into those precious profit margins. 

Management that’s not up to scratch 
This is a very hard one to admit to. Often, it may take an outsider to spot the limitations of the existing team of directors and shareholders, shortcomings which might be difficult to see or overcome for those who are too closely connected to the day-to-day business operation. 

Good management is harder than it looks. Are the people running the company up to the task? Being too nice or too overbearing can be equally as bad – neither is conducive to encouraging productivity and loyalty amongst staff. 

Effective leadership is vital for any business to thrive – that means being able to empathise with employees, not being remote, knowing when and how to delegate, having the happy knack of recruiting the right staff, appreciating the importance of staff training and knowing when to crack down when things aren’t going as they should.  

Being a good strategist is also important. You really need to be a good all-rounder and, if not, recognising where others may have skills and abilities in which you may be lacking – either within the business or in the form of external consultants or contractors.    

The Bottomless Pit Syndrome 
It is important to avoid the situation where you lose sight of the difference between what is the company’s money and what is viable salary.  Dabbling with the company bank account, as if it were a limitless pool of cash, can be a fateful step.  Just because it’s there, isn’t a reason for tucking into it!  Of course, every director is entitled to a salary – but remuneration needs to be in line with what the company can afford and should be drawn on the basis that it is taxable or as a shareholder dividend.  Directors paying themselves too much or who are free and easy with their expenses, are quick routes to insolvency.  

Location, Location, Location  
Given that modern communication has made doing business so much easier, many companies could be based on the Moon and it probably wouldn’t affect their ability to be successful! Nevertheless, physical location could well be a drawback if you rely on customers coming to you and access is poor, or road and rail links are not as efficient as they could be. Is the current location acting as a barrier to expansion? Are business rates crippling?  

Relocating to a more viable geographical position or to premises that would make the business more efficient, can be transformational in turning around a company’s fortunes.  

Marketing Mishaps  
You may well have the right product or service, it may be competitively priced and your quality control is right up to scratch – but if your customers aren’t aware of your existence, you will struggle.  In this age of digital marketing, where websites are shop windows and social media is ubiquitous, there are unprecedented opportunities to channel marketing activity. At the same time, any weaknesses in a company’s marketing are likely to be all the more obvious, given that we are all so visible to each other. 

Taking a professional approach to marketing is one of the greatest priorities for SMEs today. For a start, customers will expect to see a professional looking and responsive website that is informative and easy to navigate. 

Is eCommerce something that might add a new dimension to the business? Is reliance on selling from a physical location holding the business back? It is said that one of the reasons why household name retail stores have gone into liquidation during 2020 is because they failed to embrace the online shopping revolution. Of course, not all business will be dependent upon remote selling – but the digital landscape is only going to expand, as has been proven during the coronavirus pandemic.  

And what efforts is the business making to communicate with its customers? Interaction is important, engaging with them paramount. Social media can make or break a business in the world of 21st century commerce. 

This list is not exhaustive but, more often than not, at least one of the above scenarios will most likely have been at the root of the problem.