What is business failure?
Business failure is when your business has reached the point where it is unable to continue without running into financial problems. The business has reached the point where it can no longer pay its bills and is therefore technically insolvent. In actual fact the business has no way of meeting its obligations in the near future, and by continuing to operate puts it into further financial trouble.
At that point it could be best accepting that the business has not been successful and consider closing up. Continuing to trade can deteriorate to a situation where you as owner become liable for all additional and continuing financial woes and more people who deal with you could lose their money.
Failure is common
They say that well over 70% of businesses fail within the first 5 years. And over 50% of small businesses fail within the first 3 years, from the time the business is set up. These statistics are disputed by some. Perhaps it may be more correct to say that over 70 % of businesses close within their first 5 years. These figures would then include those who have simply closed up for perfectly legitimate reasons.
There are many causes for business failure which affects not only new business start-ups but also businesses that have been around for some time who had run successfully in the past. Business failure happens to businesses of all sizes, although the smaller businesses are exposed to bigger threats because they don’t have the back up of extra capital or resources that some larger companies have access to. Smaller businesses also have more difficulty arranging funding assistance from banking and other financial institutions.
Business owners should look for and recognise when their business has reached the point where it can no longer continue to trade and do something about it before it’s too late for the situation to be properly and legally resolved.
Failure and economic scarcity
No firm tries to be unsuccessful. Every business tries to satisfy their customers and their shareholders by making profits. If the business is unable to make profits it usually results in job losses and loss of money by investors in the business, and the suppliers of goods and services to the business. Some economists see failure as an essential factor in economic progress. They see failure as a blessing in disguise. This is because it directs the economy away from wasteful and unproductive activities and moves it more to productive areas that result in prosperity.
Our policymakers who are interested in economic success through legislation believe that an economy without failure cannot progress. This is because of the doctrine of economic scarcity. Scarcity is basically an insufficient amount or supply; that is, it is a shortage.
Some say there is a limit to the amount that a society can produce and consume at any time; therefore people have to make choices. Scarcity forces the prices of commodities, such as labour and materials into such a high bracket that the less efficient producers fail eventually. This means that resources can then be allocated to produce goods and services that are in the greatest demand, causing production to move away from the goods and services that are in less demand.
Failures are sometimes inevitable – they usher in the new
The lack of capital for the success of all business ventures explains why some entrepreneurs fail and why some industries close up. The open market only rewards those whose discoveries or goods satisfy urgent demands. Consider Graham Bell with the telephone, or Henry Ford with the mass production of cars or Steve Jobs the founder of Apple Computers, or Bill Gates the creator of Microsoft.
If the invention is beneficial to society, that entrepreneur will be rewarded handsomely. However, the benefits that do not justify the cost in a free market will not attract consumers. The bright side of any failure is that the capital and resources are reallocated for the production of other more in demand goods.
What contributes to business failure?
Business failure is caused by a number of contributing factors. Some of the more common of these are:
- Poor business knowledge.
- Lack of cash.
- No demand.
- Poor financials.
- No marketing.
- Cost of loans.
- Customer fails.
- Growing too fast.
- Not keeping to stages.
1: Poor Business Knowledge
Perhaps the one single factor that causes failure is the lack of business knowledge by the business owner or entrepreneur. It is essential for the owner to have the required core skills to manage his/her business. This does not necessarily mean that they need full-blown accountancy or financial skills, but they do need to have a grasp of the basics.
2: Lack of Cash.
Another major cause of failure is the lack of startup capital, as well as the original operating capital. If you feel you don’t have enough startup capital, it is wise to wait until you have saved enough money for this initial funding. Your lack of cash can lead to borrowing, which puts a drain on the business, as well as generates extra costs, which can bring its own problems. Lack of cash highlights one of the major reasons why businesses fail within the first 3 – 4 years.
3: Lack of Demand.
The products and services you supply to consumers must have demand. Naturally, if no one wants to buy what you have to sell, your business will be in trouble. Even if you have an experienced and skilled sales team, if nobody wants what you are putting on the market, then why should consumers change their minds simply because of the sales tactics used? In general no sales will result in no business and so you need to know where, how and who will bring in your sales once you begin operating.
4: Poor Financials.
Every business needs to maintain adequate accounting and other systems so the business can monitor how it’s going and where it’s going. If you fail to do so, you will easily lose financial control of your business, including such things as cash flow problems that will force your business to close. If you don’t possess accountancy skills you should employ someone to look after this area. It is critical that your business has someone to look after the financial accounts (for external use such as taxation) and management accounts (for internal use such as for managers to direct the business) and for other purposes such as cash flow and forecasting.
5: No marketing.
Many small businesses do not look on the requirement for marketing as important. They have little knowledge of marketing and as a result tend to skip this important requirement. They know that it costs money to put it together, so it is not given priority. As a business owner you need to have the right attitude towards marketing and what it can produce.
6: Cost of loans.
If you need extra funding because of lack of initial working capital, the cost of these loans has to be taken into account in your profit calculations. You have to manage your business with a keen eye towards interest charges and other costs. If a small amount of funding is needed, it may be preferable to request close family and friends to help you temporarily, rather than seeking outside funding because of the cost involved.
7: Growing too fast.
Believe it or not, many small businesses fail because they are doing too well. That is, they are growing too fast. If you sell more than your business is capable of supporting, this will put a strain on various aspects of your production, as well as your sales and cash flows. Insolvency by over-trading is common because, in order for your business to catch up with the sales being generated, it has to borrow more money to compensate for the increased cost of staff, materials, etc. This is one area you do have to look at carefully, if the demand for your products is better than you had originally expected.
8: Customers fails.
Business failure can also be caused by other businesses failing. If they close up or go into liquidation the amount they owe you will be in jeopardy. It also comes about if other businesses take a long time to pay your bills, because it will leave you with cash flow problems. This can happen if the other business experiences its own cash flow and financial problems, so look at this carefully and keep an eye on your suppliers.
9: Keep to the stages.
There are 3 main stages of business development:
- Starting up stage.
- Establishment stage.
- Competition and expansion stage.
Each of these stages needs a different approach, so it is important that you watch this carefully. Many businesses fail because they move on to the next stage far too early and consequently this contributes to business failure.
Unfortunately, the paperwork that small business has to cope with today can easily lead to business failure, just because of the time required to fulfil obligations under the various legislation. The time and money needed to administer these obligations is difficult for business owners because their attention is taken away from the essential requirements of running their businesses, and running them profitably.
Good business knowledge is one of the keys
The first and most important thing you need, in order to succeed in a small business, is good business knowledge. They say that at least 90% of all small business failures can be traced to the fact that the business owners had little or no knowledge about how to run a business let alone a successful one.
Obtaining this knowledge can involve you (as the business owner) taking a small business course or reading up on all the areas involved in starting, running and growing a business. One of the most important things you have to do when you are desirous of starting a business is to calculate the feasibility of your idea. You need to do a feasibility assessment and if this shows that the business has no likelihood of making a profit, then it has to be set aside.
A small business owner can avoid many mistakes and he/she will not know about this without that knowledge. Good business knowledge plays such an important role in determining success or failure that it would be a good idea for the government to bring in a simple registration process, where no one can start a business without passing a very basic exam on how to set up and run a business.
Talent or skill is not enough to guarantee success. Have a great vision plus the resources and capital would help. In the end, however, success will be determined by the ability of the business owners or the managers to put all the areas of a business together; from production to sales, to marketing, to accounting and finally to completion of financial accounts. If you are contemplating starting a business, it is recommended that you do not do so until you have educated yourself on the basic knowledge of business operations.