The Main Causes of Business Failure

What causes businesses to fail?

#1 The poor management of cash flow
The poor management of cash flow is the main reason that small businesses fail.

It is possible to have a paper profit but still have problems simply because there is insufficient cash flow to pay creditors. Poor cash flow may arise from:

  • Significant increases in stock levels
  • Inadequate credit control
  • Increasing debtor days
  • Bad debt incurred
  • Poor accounting practices including late invoicing
  • Inaccurate forecasting by management
  • Failure to plan for capital and/or exceptional expenditure
#2 The loss of main trade accounts
The loss of main trade accounts causing a reduction in turnover and possibly trading profits is another principal cause of businesses finding themselves in financial trouble. The business will often then offer substantial discounts and extended credit terms in an attempt to generate sales, however, this causes further pressure on cash flow. Unless a business is in the fortunate position of being able to reduce overhead costs to compensate for the loss of turnover. It is essential that the loss of a major client is replaced as soon as possible.
#3 Lack of management control
Lack of management control is another major reason why business find themselves in difficulties. All businesses need to have a strategic plan to ensure that they are operating in the best markets with correct margins and adequate level of financial resources. All too often management spend too much time dealing with day to day problems and so fail to address these fundamental issues. Lack of management control may result from:

  • Failure to develop a business plan
  • Failure to understand costs, markets and key customers
  • Failure to submit returns, resulting in penalties and possible investigations allowing customers unnecessary discounts
  • Wasting time fending off creditors
  • Wasted promotional expenditure
#4 Inadequate or inappropriate financing
Inadequate or inappropriate financing is the fourth major cause of company difficulties.

  • Use of short term overdrafts for long term capital acquisitions
  • Failure to use factoring facilities when sales are substantially increasing
  • Inadequate shareholder capital all contribute to cash flow problems
  • These problems will become more pronounced when a substantial difficulty such as a major bad debt, loss of a principal customer or business interruption occurs.

The Solutions

In addition to the above list there are numerous other reasons why businesses become insolvent including excessive remuneration and uninsured losses arising but the most common cause remains the failure by management to manage their business. Where management takes a proactive stance, controls the situation and seeks advice where necessary, whilst they will not be immune to the possible downturns of the economy, they will be much more likely to survive.

If you would like to find out how credit insurance can help your business, please contact our Account Management team..