9 Financial risks of small businesses in 2023

DAVID FAČKO

11 min

·

November 27, 2023

Are you prepared for the financial challenges 2023 may bring to your small business? According to Forbes, The US alone has over 33 million small businesses. Out of these, more than 80% have a single employee. Individually, small businesses only impact the economy a little. However, when you consider them collectively, it entirely changes the picture.

From a small business point of view, mistakes are less costly than they are in bigger organizations. The scale is smaller, and getting back up is usually easier after a setback. Having said that, a business thrives and scales when it manages to minimize or avoid specific threats.

Roughly 2 out of 3 small businesses face financial risks. More often than not, it’s due to entrepreneurs needing more experience. You cannot predict when a challenge will come your way. Hence, recognizing and preparing for hardships in advance is a better strategy. Be proactive and navigate the obstacles by familiarizing yourself with these financial risks.

9 Financial Risks Small Businesses Must Prepare for

Are small businesses ready to face the financial hurdles of today’s economy? This article highlights the 9 critical financial risks small businesses must prepare for, offering insights and strategies to navigate these challenges successfully.

1. Missing Legal Framework

Beginners undergo legal frameworks because they want to save money on hiring lawyers who prepare all the necessary documents.

Such a mindset won’t lead to long-term success. Running a business comes with legal matters. Even a slight error, such as misunderstanding a law and failing to check with authorities, can lead to penalties. Ignorance is not an excuse. Regardless of how big or small a business is, its documents have to be in check.

If your competition or partners realize your operations are illegal, they will cut ties. Or, worse, they will report you to authorities.

The same thing can be said about employees, especially those working remotely. Neglecting to prepare a legal framework because “nobody cares or will find out” is the opposite of what a small business owner should think. Generally, enterprises operating while ignoring the law are liable and bound to face consequences beyond financial risks.

2. Failing to Diversify Income

Failing to Diversify Income

A small business might have fewer income diversification opportunities. Still, with an ever-changing economy and market conditions, failure to adapt presents a significant risk. The more diverse your income, the more leeway you have to experiment and make mistakes. Your overall financial footing becomes more stable.

What are your options to diversify? It depends on the business type. Let’s say that a custom merchandise store is looking to expand. Their best option is to add new products or hire fresh designers to add fresh merch ideas.

Exploring new sales channels is another worthwhile suggestion. If you’ve focused on online sales, why not contact physical store owners? They might be interested in striking a partnership and selling your goods.

Finally, expanding the customer base should be a priority regardless. A small business can only sustain itself for so long by relying on a small pool of regular customers. Expanding the customer base is inevitable if the enterprise’s entrepreneur aspires to expand and turn the current version into a more profitable and sustainable model.

3. Managing Credit

Credit management plays a prominent role in determining the success of small businesses. A lack of credit policy indicates that the people running the venture are not taking their responsibilities seriously.

Monitoring and maintaining credit scores is imperative so the business is in good standing. Poor credit score dissuades potential lenders from giving out loans.

For starters, make sure that you pay all bills on time. A commercial credit score depends on a positive payment history. 

Before committing to a deal, set a realistic time for your bill payment. You might be eager to overpromise a payment date but fail to deliver. Double-check with the accountant or another person handling that side of the business. Ensure you have a clear understanding of the invoicing payment terms before proceeding to settle the invoice.

Once you get confirmation, speak to the recipient. Setting a realistic timeline and delivering is much better than overpromising and missing deadlines. A business should still have a dedicated business credit file, even if it is small. The purpose of such a file is to collect and track relevant information to make sure that your relationships with the following parties are intact:

  • Suppliers
  • Customers
  • Financial institutions

Remember to keep the document up to date with information related to the business. Changes in registration address, new expansions, employee numbers, pending lawsuits, etc., must be on the document.

By maintaining a solid credit score, you will have fewer struggles securing good financing terms. In addition, a firm credit management policy also helps fend off fraudulent activities

Business credit risk score

Fraudsters can easily expose an organization’s vulnerabilities if the business struggles to manage their credit file properly.

4. Keeping Accurate Tax Records

Some small businesses ignore tax liability, thinking they will slide through and escape unscathed. The consequences of non-compliance with law regulations are extremely dangerous. A small error here and there is OK. However, if the records are clearly forged for the benefit of the business and the institutions get the hang of it, prepare for trouble.

Keeping accurate records can be tricky if there are hundreds or thousands of transactions to keep track of.

Automating invoices and other processes where possible with the help of software reduces the workload and leaves less room for errors.

Still, a professional accountant remains essential. A dedicated person who tracks and registers financial transactions is too valuable to pass up. 

Pro tip

Plan your taxes. Try to project what the expectations are for the next fiscal year. Look at previous years and predict what to expect.

Knowing there’s money to cover the upcoming tax payment gives peace of mind. Set some money aside every month for your rainy day fund. Prevent invoicing issues by using Billdu, and discover small business tax tips for saving money.

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5. Picking Bad Investors

Small business owners are eager for opportunities to receive investment and boost their standing. A fresh money influx is always welcome, especially if a venture struggles to survive.

The problem with investors is that most business owners do not bother researching the investor. Instead, they jump the gun and take the money without a second thought. It’s all well and good if the deal turns out alright, but going in blindly shouldn’t be the approach of your choice.

For one, an ideal investor should go beyond just giving money. Suppose you had to choose between an investor that offers monetary gain and access to a professional network and an investor that offers just money. In that case, the former is the obvious choice.

Of course, small businesses can hardly be picky when finding investors. For some, having an interested party is already a great advantage.

Still, one must remember that investors do not throw money without reason. They expect to get ROI. And if somebody sniffs an opportunity for a potential takeover of a successful venture and invests because of that, the original business owner risks losing their creation.

As a rule of thumb, you shouldn’t say YES right away. Regardless of how tempting an offer is, weigh all the pros and cons. Consult with others to determine whether an investor is right or wrong. 

6. Having a Bad Recruiting Strategy

Even though most small businesses have a single employee, plenty of entrepreneurs still look for opportunities to grow and recruit new employees.

Staff growth is an indicator that a business is healthy and growing. After all, hiring new people makes sense when the enterprise is stable.

Unfortunately, that happens more than you might think. Recruiting new employees with little thought is usually the result of poor estimations.

A business owner might need to realize they cannot afford additional workers yet still go for it. Basing important decisions on personal expectations is one of the first steps toward downfall.

For instance, you might think you will strike an excellent deal soon, and the client will pay up. The payment should improve the cash flow, so paying new staff members will be fine.

But what happens if the deal fails and you have already hired and promised payment to your new employees? You cannot hire new people based on promises. 

Similarly, a financial risk stems from underestimating a new recruit’s value to the organization. 

If somebody submits a resume and presents themselves as an asset to the company, it doesn’t mean it’s the reality. A bad recruiting strategy leads to redundant employees. Keeping someone on a payroll just because you can is inefficient.

hiring the right people

Overhead expenses accumulate over time, increasing financial risks and affecting the company’s ROI. 

Not only should you hire employees who earn their salary, but you should also let go of those employees who become obsolete. It’s always tough to lay off a close colleague, but the action is justifiable if you do it for the company’s good.

7. Underestimating Liquidity Risks

Some small companies fail to meet financial obligations due to poor planning or external factors (the recent pandemic is an excellent example).

It also doesn’t help when seasonal changes dictate how a business should operate. For instance, skiing resorts or Halloween retailers have downtime. Hence, they need to project their finances and estimate how much danger liquidity poses.

Running out of money to pay property taxes, salaries, and so on puts the business at risk of shutting down. Small enterprises have fewer resources and are at a more significant disadvantage. As stressful as thinking about it is, keep liquidity at the back of your head. Project future money flow from items on your balance sheet. Get in the habit of managing your money. Doing so will let you identify liquidity risks and prepare for the worst-case scenario.

8. Setting Prices That Are Too Low

Fresh businesses have to go up against competition. Underpricing goods and services is an easy strategy to differentiate yourself from others. Such a way of operating makes sense early on. Yet, what happens once the operating costs have to go up? 

Customers who become regulars will be unhappy about a price increase. It doesn’t take too long for loyalty to disappear if they feel like the brand mistreats them. Overcoming this problem is quite challenging. A small business cannot sustain itself if it’s not making profits. 

The best bet is to research the market, particularly customer behavior and how they would react to the changes, and present the adjustments with clear explanations. Justifying price increases is easier when brands are transparent and take the time to explain.

9. Choosing Partners Without Much Thought

Similar to how small businesses look for investors, they also look for potential partners that help expand operations. The risk that comes with collaborations is how dependent you become on others. The dropshipping business model is a great example.

You don’t have to worry about the logistics side of the business because suppliers manage shipping, returns, refunds, and so on. Instead, your focus is on customer experience and marketing.

Dropshipping is attractive thanks to its low initial costs and smaller risks. Still, once you get the operations up and running, you must consider the importance of the supplier. 

If they decide to stop sending the goods or have a sudden drop in quality, you risk your business failing. Relying on others is fine. After all, there are plenty of successful companies that built themselves thanks to dropshipping.

The most important thing is to find the right partners. For instance, dropshipping suppliers from the USA or Europe might be more expensive than suppliers from Asia or Africa. Despite that, you can expect the former to be more reliable. To further mitigate risks, implementing a supplier risk management software solution can help evaluate and monitor the reliability and performance of your suppliers. This ensures that potential issues are identified early and appropriate measures can be taken to maintain smooth operations.

And remember—this applies not just to dropshipping but to other partnership opportunities, too. At the end of the day, running a business with other parties is much easier when you know you can trust them.

Wrapping Up

To sum everything up, a small business can be profitable by itself and even lead to financial independence if you play your cards right and scale the venture in the future.

However, understanding that entrepreneurship comes with certain challenges, including financial risks, is critical. By identifying potential risks early on and understanding how they work, you should be able to create a strategy to address and minimize the threats. 

Take as much as you can from this article and apply it to your venture. Go that extra mile to secure your financial future.

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DAVID FAČKO

SEO Specialist at Billdu

David Fačko serves as an SEO and Content specialist at Billdu, globally recognized as one of the top-rated invoicing software solutions for freelancers and small businesses.