Why do businesses fail?
There are lots of rather grim statistics on business failure. Start-up businesses especially have a poor track record. Data shows that 30% of new businesses fail in the first year and 60-75 % are no longer in business after 5 years. Existing businesses also fail after being in existence for a long time.
Some of these “failure” statistics are overstated since many businesses voluntarily stop operating. Business owners retire. Other, better opportunities come along. Some start-ups really were never committed to be “in business” but theirs was just a part-time activity or experiment.
However, business failures are real and prevalent. Why do businesses fail?
One of the biggest reasons is under capitalization (a fancy phrase for not starting with enough money). Many businesses do not prepare a business plan and thus do not have a cash flow forecast. They really don’t know how much money they will need to start-up, continue, or expand their business. They run their business based on how much capital they have, not what they need. Unfortunately, some of these businesses have a good potential for eventually being successful, but they just run out of money before they can “get over the hump”. Some businesses start with enough capital but unwisely spend it too soon, before they have made proper purchase evaluations. Sometimes leasing rather than buying helps preserve your precious capital. Also, maintaining good relations with your banker helps so that when you need more capital, he is informed and can help you better. Sometimes businesses just make wrong purchase decisions. All of these contribute using up their capital.
Poor management of accounts receivable contributes to major problems. Evaluating the creditworthiness of potential customers in the first place is critical, but a sound collection plan is also important.
Too high an overhead is also a major problem. Some overhead is needed, but small businesses must be financially flexible and able to move quickly when opportunities arise. A big overhead prevents this. Overhead can reduce your gross margin and prevent you from being competitive or having promotional pricing flexibility.
In my opinion most business failures are marketing based.
Expanding too quickly or at the wrong time puts great pressures on management and financial resources.
Not following the market dooms many businesses. You have to stay in touch with the market in general and your customers, specifically. Do you have a market research program? Do you know what the trends are in your industry? Belonging to, and being active in, a trade organization in your industry can help.
Another significant cause for business failure is trying to compete on price. Small businesses need to concentrate on service, customization and treating their customers so well that they won’t go anywhere else. Be competitive, but being the cheapest is for the big boys.
Finally make sure your revenue does not come mainly from one source. If you are too dependent on one big client, disaster can strike when that client goes somewhere else, decides to make the product or provide the service himself, or he goes out of business. His business failure could be yours.
So don’t become one of those business-failure statistics. Have a current business plan. Keep in touch with your banker. Watch your overhead and work on your marketing plan. Good Luck.
This article was written by Seattle SCORE Chapter member Fred Parkinson for the Kitsap Sun in Bremerton.