Why do businesses fail?

The reasons for business failure are extensive. This article will provide readers with an opportunity to understand the main causes of business failure and how, at times, they are easily avoided.

As Insolvency Practitioners, it is our duty by Law to investigate into the affairs of an Insolvent Business and, more importantly, determine what caused it to fail. This assists governing bodies to compile statistics and determine the trend allowing new business owners to escape the same mistakes and errors of their predecessors.

On many occasions, a Company Director or individual Bankrupt will inform us that it was the impact of the recent Global Financial Crisis (“GFC”) which caused the demise of their business. Whilst at times this may in fact be correct, there are many occurrences where this is used as a general excuse. It is only prudent of us as Insolvency Practitioners to advise business owners and, on a wider scale, the general public on the most frequent and common causes. A snapshot of primary grounds for business failure are listed and explained as follows:

1.    Poor Planning;

Prior to registering a business, it is crucial that owners take the time to properly plan and implement a strategic approach of carrying on its activities and operations. This is otherwise known as a Business Plan which covers, amongst other things, the purpose of the business, management and administration, marketing and finance and even discloses its mission statement. This simple statement gives the owners a target and direction on what they are attempting to achieve by starting a business. An excellent example I can offer to readers at this point is Walt Disney’s Mission Statement which clearly states: “make people happy” I am confident that there are not many readers which find the results of Walt Disney’s Business Activities contrary to their statement.

An acronym we provide to our network is the six P’s of successful performance: Prior Preparation and Planning Prevents Poor Performance.

2.    Poor Management

This indicator is arguably amongst the most common cause for business failure. This stems as a result of Directors either becoming too involved with a different area of the business, inadvertently neglecting ongoing management or, merely, they do not have the skills required to accommodate this function.

Every business is different and therefore there is no one specific answer in how to manage a business. Rest assured though, there are sufficient guidelines and models to assist owners in implementing a sustainable and strategic system.

3.    Inadequate working capital

Working Capital can be simply formulated as:
Accounts Receivable (Debtors) + Inventory – Accounts Payable.

In Business, “Cash is King”. In order for a business to continue to meets its debts as and when they fall due, they need more cash than they do liabilities. As such, it is important that business owners focus on having more Debtors and Inventory in their business than they do Creditors. This allows a surplus of cash and cash reserves, providing business with the opportunity to effectively use this surplus elsewhere.

Failure to have this surplus of cash may force the business to reinvest by either way of capital contributions or long/short term debts resulting in a constraint on the business and ultimately leading to its failure.

4.    Directorial conflicts;

Similar to a matrimonial divorce, disputes amongst Directors can have different damaging outcomes, such as:

i.    Director Removal;
ii.    Selling the Business;
iii.    Winding Up; and
iv.    Several other reasons.

It is therefore essential that all disagreements, especially at Director levels are dealt with in a professional and timely manner. If the need arises, the business should seek the employment of a conflict resolution professional.

5.    Legal Issues

There are infinite reasons as to why a legal dispute internally or externally can cause the demise of a business. A perfect and common example of this cause is copyright infringement and the Director’s misjudgement in not obtaining appropriate legal advice.

While there are many who dislike the term Lawyer or Solicitor, a proper professional will ensure the business’ legal obligations are met.

As this article provides a brief summary of main reasons why businesses fail, readers should be aware that, in reality, a business can fail for any reason. While operating a business is difficult and challenging, it is imperative that interested business owners properly cover all areas of their operations by utilising the six P’s and, if necessary, seek appropriate advice of a professional.