3 Mistakes That Will Sink Your Small Business

By Asit Sharma Markets Fool.com

As a Motley Fool contributor who also advises small and medium-sized businesses on finance and strategy, I can attest that the same mistakes that put small businesses out of commission can also sink Fortune 500 companies.

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The only difference is that the largest corporations, with their commensurately bigger balance sheets, simply take longer to fail. In the interests of buoyancy, then, let's walk through three mistakes that can prove fatal to small businesses if left untreated.

1. Standing still while market demand evolves

Each day, the demand for your company's products or services -- your offering -- is in flux. One of the primary tasks of a small business owner is to connect what he or she is selling to a vibrant market where demand is vigorous.

Capturing and filling current orders is commendable, but to run a sustainable enterprise, you must also ensure that tomorrow's demand is as high, or higher, than today's. This can be achieved through expansion into new markets, or through innovation within your offering.

In the year 2000, IBM's (NYSE: IBM) most notable cash cow was the computer server -- the software giant sold nearly $11.5 billion worth of them that year.Today, servers still figure in IBM's product mix, but their sales have dwindled by more than 70% in the 21stcentury, making up just 4% of IBM's total revenue last year.

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The names of major business segments you'll find in IBM's most recent annual report, like "Cognitive Solutions" and "Cloud Services," indicate how much IBM has evolved to continue to fill market demand.

How can a small business gain similar insight into its own product and service lines? An under-appreciated exercise is the development of a two- to three-year sales forecast. While small businesses often neglect this task, or treat it informally, a rigorous approach to forecasting can save companies much economic grief further down the road.

What will your offering look like three years from today? Who will purchase it? What market conditions will hinder or improve your ability to show revenue increases over the next few sales cycles? These are the types of questions that will naturally arise when a motivated, thoughtful owner or team is faced with plugging forward-looking sales numbers into a spreadsheet.

In essence, demand never ceases to fluctuate -- you have to keep ahead of it. Use a forecast as a starting point to understanding your market, and to determine what about your offering needs to emerge for revenue to increase.

Image source: Getty Images.

2. Mistaking profit for cash flow

What's more important: profit, or cash flow? In a small business, it depends on where you are in the cycle of converting sales into cash. Enjoyment of a profitable month on paper can quickly turn to pain if that profit gets tied up in receivables that take inordinate amounts of time to collect.

Lacking the working capital solutions that large corporations can access, small businesses must optimize the time it takes to fulfill obligations under a sale, and collect and deposit money into company coffers at a brisk clip.

To keep your business from mistaking profit for cash flow, review the aging of accounts receivable regularly. A standard four-column accounts receivable aging report (which isolates the due dates of receivables in 30-day columns) sheds light on the timing of collections and helps you plan for the availability of cash against upcoming expenses.

Equally important is a rational approach to extending trade credit. Before beginning a new customer relationship, you should evaluate that customer's ability to pay on acceptable terms and in a timely manner.

Dun and Bradstreet(NYSE: DNB) offers cost-effective research reports for small businesses that can help vet the creditworthiness of prospective customers, and assist in establishing the initial upper limit of credit to be extended.Calling at least three trade references is also an effective and time-honored practice that adds needed color to your customer evaluation.

It's not enough to record revenue from your offering. Fulfill your sale obligation quickly, and collect your funds in a timely manner. Image source: Getty Images.

For retail and online businesses that collect money up front, trade credit may not be a significant concern. In this case, be cognizant of merchant costs. It's crucial to find a cost-effective platform for processing credit card or online transactions. Over time, a few unnecessary additional percentage points of transaction expense can eat into your profits -- especially if your business carries a net profit margin in the single digits.

In sum, solid cash management ensures that profits will realize their destiny as cash and protect against the slumps growing organizations inevitably experience.

3. Misunderstanding where employees fit in your financial equation

It's not hard to see why a small or medium-sized business would agonize over a relatively large equipment purchase. We can easily grasp the impact of a sizable fixed-asset addition through the cash outlay, any additional financing required, and the appearance of the asset on the balance sheet.But when it comes to employees, those who manage small businesses often make hasty hiring decisions without appreciating the ever-present, long-term economic ramifications.

What if you were to take the lifetime expense of just one employee, including benefits, employer taxes, and associated overhead costs, and roll it into a single number? For the vast majority of businesses, labor expense is the first or second biggest line item on the income statement after cost of goods sold.

In his seminal book on best practices in business, "Good to Great," author Jim Collins extolls the virtue of getting the "right people on the bus," versus simply hiring to fill a position. Collins even recommends that in some cases, it's acceptable to hire truly talented employees who will push your company forward, even if their exact position in the organization isn't yet fully staked out.

While business owners may often set strategy, ultimately, the fate of a company rests on the small decisions and actions made each day by each employee.So, don't make the mistake of ignoring what employees mean to your financial equation. Each person in your business is either contributing value, or diminishing it. And a string of truly bad hires can sink a business just as fast as a series of failed product introductions.

I'll leave you with a simple rule of thumb: For a growth-oriented company, focus on hiring the best employees your profits will allow. Bring those on board who will challenge your assumptions, create new ideas vis-a-vis strategy and operations, and of course, improve your offering so that it's always positioned in front of market demand.

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Asit Sharma has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.