Reasons for Business Failure 

Business failure 

A major cause of business failure is a lack of cash flow. A business can face serious problems if they don’t have enough money coming in to cover costs. A customer paying late may mean a business is unable to buy supplies or pay its employees. 

Another big risk that a business faces is the failure to make enough money to survive and being forced to close. This usually happens due to poor revenue, which can be caused by: 

• a lack of market research to find out what customers want 
• running out of raw materials 
• poor management, with not enough thought given to the consequences of decisions on how to manage the business 

Here are some more reasons why business might fail.

CASH FLOW PROBLEMS

Many businesses fail because they run out of cash. Some entrepreneurs focus too much on profit and forget about the importance of cash. There are a number of reasons why a business runs out of cash: 

OVERTRADING 

• The problem is that businesses’ cash runs out while it is spending money on resources to meet a rising number of orders. 

INVESTING TOO MUCH IN FIXED ASSETS 

• over-investment in new assets such as machinery or equipment. 
• When a business first starts trading, funds are limited. Spending large amounts initially on equipment, vehicles and other capital items can quickly use up resources. It may be better to lease some of these fixed assets to protect cash reserves. 
• Lease-legal agreement that allows you to use an asset such as building, vehicle, or machine for a period of time, in return for rent. 
• Fixed assets- resources used repeatedly for a period of time by a business such as property, tools, vehicles and machinery 

ALLOWING TOO MUCH CREDIT

• Too long for customers to pay bills. A lot of a company relies on loans. This means that the product is being sold and paid by the consumer afterwards. One of the concerns is that companies enable their clients to pay too long to wait for the money and may be required to take it over that time period. 

OVER–BORROWING 

• Businesses can borrow to finance growth. Since additional lending is carried by the bank, the costs of interest will increase. To avoid debt, a company may try, perhaps by selling shares, to raise more funds from the shareholders. 

SEASONAL FACTORS 

• Sometimes trade varies for seasonal changes. For example during Christmas holidays people would buy Christmas cards. 

UNEXPECTED EXPENDITURE 

• Businesses need to be prepared for any unforeseen expenditure. Equipment breakdown, tax, demands, strikes and bad debts are common examples. 

EXTERNAL FACTORS 

• Sometimes events outside the control of the business cause cash flow problems. Examples include changes in consumer tastes, changes in legislation, or a downturn in the economy. 

POOR FINANCIAL MANAGEMENT 

• Inexperience in managing cash or a poor understanding of the way cash flows into and out of a business may lead to cash flow problems. 

LACK OF FINANCE 

• Corporations may fail if they are unable to attract finance. Established companies could struggle to receive financing because their track record is poor, thereby putting investors at too high a risk. New companies would have a hard time attracting finance because they have no trade history and are too risky again to investors. Some entrepreneurs believe that they may survive with limited cash by being careful. This means they might be UNDERCAPITALISED. If a business does not raise enough money before trading begins it will risk failure. 

NOT COMPETITIVE 

Some businesses fail because they are unable to compete effectively in the market. Reasons why businesses lose out to their rivals: 

New Entrants – A business fails because a new rival enters the market and takes away their trade. Many small businesses collapse because they are overrun by larger competitors in the market. Competitors might: 

• Charge lower prices because their costs are lower (eg materials/resources bought from a cheaper supplier) 
• Use ‘destroyer pricing’ (very high discounting), if they are a powerful company, to drive smaller rivals out of the market – this might happen when a company ‘dumps’ a cheap product in a foreign market. 
• Bring out superior products eg. Nokia and Apple. 
• Read market conditions more effectively – for example some businesses fail because they bring out products that are unpopular in the market. 

INEFFECTIVE COST CONTROL

Sometimes, businesses cannot keep their cost lower. If costs are too high then a business needs to charge more to make a profit. This might result in a loss of trade to low-cost competitors. 

• They may be too small to exploit economies of scale, large rivals that produce much more output enjoy lower unit costs. 
• They may be wasteful and lose control of its cost.
• The business might be spending too much resources. 
• The business might not be minimising labour costs. 

INEFFECTIVE MARKETING

Businesses might struggle to compete if their marketing is weak. 

Some businesses fail to launch and market a new product. Eg. Colgate, the tooth paste producer, once launched a line of convenience foods. The product was a complete failure. The business might not use the best pricing strategy (not too high or too low) – customers might think they are ripped off or the quality is bad. 

LACK OF BUSINESS SKILLS

Some businesses lack competitiveness and fail because their owners are not sufficiently skilled. For instance, IT, marketing, etc. 

POOR LEADERSHIP

Some cases have led to the downfall of businesses by senior management and leaders. A company could lose its competitive edge in the market because the leader is wrong. 

FAILURE TO INNOVATE

Some businesses are not flexible due new technology has not been used in the production or marketing industry. In addition, some companies don’t want to take additional risks and invest money. Sometimes companies rely on old products that cause them to collapse. 

Vocabulary: 

Inventory – stocks of goods

Undercapitalised – starting a business with insufficient capital