Companies go out of business for many reasons, but the end result is the same: the company shuts its doors and stops providing much-needed services and paychecks. Your financial statements can give you the early warning signals that something is going wrong. The trick is to be able to see these red flags and appropriately respond to them before it is too late.
Here are five warning signs:
1. All of Your Eggs Are in One Basket
It's tempting to ease up on sales and marketing when your company is doing well. However, your pipeline might not be as full as you think, especially if much of your revenue is concentrated among a few customers.
Look at your customer list and determine the percent of overall revenue each customer contributes to your company (see the QuickBooks Income by Customer Summary report modified to show percentages by customer). If any one customer is providing more than 10 percent of your overall revenue, you need to start diversifying.
2. Your Line of Credit Is Your Major Source of Cash
If the outstanding balance on your Line of Credit (LOC) keeps hovering near the top of your limit, watch out. Staying near the upper limit of your LOC without paying it down is a sign that you are not generating enough operating cash to keep your company alive. The red flag for this warning sign is found on your lending statement.
3. Your Customers Are Strangling Your Cash Flow
Companies go out of business when they run out of cash - if you are not collecting on your Accounts Receivables, your ongoing source of cash has just dried up. The red flag for this warning sign is found in your list of outstanding accounts receivables (QuickBooks A/R Aging Summary report). Begin following up with companies that are more than 30 days outstanding to find out when (or if) you will be paid. Consider using the services of a factoring agent to help speed up your cash receipts going forward.
4. Your COGS Is Too High
If your Cost of Good Sold (COGS) is too high, you are not making a profitable product - you are either priced to low or your costs are too high. Review your COGS percentage for the last three years and see if this number is rising (QuickBooks Profit and Loss report modified to show percentage of revenue). If so, you need to look at raising prices, work with your suppliers to decrease expenses, or look for efficiencies in your workplace, such as administrative costs.
5. Your Administrative Expenses Are Causing a Long, Slow Death
It's easy for administrative expenses to increase, but the end result is the same as if your COGS are too high - you will slowly strangle the company. Review your administrative percentages for the last three years and see if this number is rising (QuickBooks Profit and Loss report modified to show percentage of revenue). If so, you need to start strategizing on ways to decrease administrative expenses so your bottom line stays healthy.
All of these warning signs can easily be found using QuickBooks or other financial software. Know what number to look for, respond appropriately, and plan for a long future as a business owner.