Why Did So Many Small Businesses Get Into Trouble So Fast At The Start Of The Covid – 19 Pandemic
Sitting here waiting for life to get back to normal or at least whatever the new normal is, I find I have a lot of time to contemplate the response of small and medium sized businesses to the Covid-19 epidemic. What surprised me most was early on the SME’s were saying that they couldn’t meet their bills as they came due. In many ways this mirrored the response of many individuals who were living paycheque to paycheque. As soon as they lost their paycheque, they had no savings to fall back on. In the case of businesses, I am guessing this meant they had no reserves to fall back on. This led me to think how we got into this situation and what we should change in order to minimise the effects of future crises, be it another epidemic or recession.
I don’t think that there is one easy answer, but I do believe that a large part of the problem lies in the mantra that growth is not only good but necessary. This may work for countries and large companies, but it is usually a recipe for disaster for small and medium sized companies. It frequently leads them into taking injudicious and unnecessary risks. In my experience these companies should be focused on building solid and sustainable bases upon which future growth can be based. This is not as sexy and not as glamorous, but it does work. Unfortunately, this is not what we are taught in business school. We are taught that fast growth is good. Unfortunately, the majority of the case studies and companies the schools look at are large companies, not small business. While many of the topics can be applied to small and medium sized businesses, they have to be applied with the understanding that they do not have nor do they have access to the resources available to those businesses. This problem is compounded by governments who say that they are there to meet the needs of SME’s but in actually fact are more often than not looking for the next ‘unicorn’ aka a rapid growth company. Unfortunately, for every Amazon, there are hundreds of businesses that never make it. This attitude further encourages small businesses to take unnecessary risks and to overreach themselves and to build their businesses on quicksand rather than a solid surface.
There is more to it than this of course. This love affair with growth often leads to problems from day 1. In the rush to get into business, we don’t think about how long it will take to develop a stable cashflow. Sometimes the initial results can compound this and lead to overconfidence. Consider a new retail business. It is not unknown for a new retail store to be swamped in the first two to three weeks. The assumption is that this level of business will continue so it's tempting to relax. Unfortunately, this ‘new store’ bump often disappears considerably in the following weeks and leads to disillusionment and cashflow problems, caused by decisions made on an assumption of cashflow continuing at the levels of the first few weeks. This is why when I teach entrepreneurship, I usually recommend that you have sufficient capital to cover six months operating expenses even if no customers walk through the door. With that comes the recommendation that as the business grows, they reinvest a significant portion of their income back into the business to cover the future growth of their business. Unfortunately, what is more common is that as soon as the business starts to grow, the principals take out more money to meet the lifestyle demands that their relatives and friends seem to think go with owning an independent business.
This brings me to the next misconception; it is not okay to lose money in your first or any years for that matter. You should always make enough money to cover your operating costs. The idea that it was okay to lose money arose from the confusion between making money and recovering your capital. It is highly unlikely that a new business will recover its capital in year 1 and if it’s growing, for a significant time in the future. In the latter case, it is more likely to be tying up even more capital. After all, if I take money out and do not have enough to cover my payments, isn’t that what the banks are for?
For businesses wanting to grow fast, banks are part of the solution and part of the problem. Interest rates have been very low for a significant period of time and it has never seemed like a better period to borrow, to try and speed things up. Recently, we have had a situation whereby companies wanted to borrow, and banks wanted to lend. This has led some businesses to an over reliance on debt. The problem with debt is that the banks expect their money back at some point in the future. While times are good this is not a problem, but as soon as things decline, this becomes a major drain on cashflow and just compounds all of the other problems facing the business. This problem has now been exacerbated by government bailouts to businesses coming in the form of loans. Yet more debt that has to be paid back in the future.
The other thing that I think contributed to the situation, was that the businesses were living in the moment and imaging that things would continue as they were. There was no long-term planning. If they were, they would have been listening to the economists who were warning businesses that they anticipated a major recession some time in the near future. Remember this was before Covid-19. If they had taken notice of this warning, they would have already started preparing for a very different future, putting plans in place for a more challenging sales environment and scaling back their operations. If they had been doing this, the Covid-19 epidemic would not have caused them so much grief.
So, what is the point of my blog. It is that small and medium sized businesses should first focus on building a solid and sustainable financial base rather than being seduced by growth before they are ready for it. That’s not to say you should not look to grow your business, just do it once the solid, sustainable base is in place. Just do it a less risky way.
Remember slow and steady wins the race.
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