A business failure is an unfortunate circumstance. Although the majority of firms that fail do so within the first year or two of life, other firms grow, mature, and fail much later. The failure of a business can be viewed in a number of ways and can result from one or more causes.
TYPES OF BUSINESS FAILURE
A firm may fail because its returns are negative or low. A firm that consistently reports operating losses will probably experience a decline in market value. If the firm fails to earn a return that is greater than its cost of capital, it can viewed as having failed. Negative or low returns, unless remedied, are likely to result eventually in one of the following more serious types of failure.
A second type of failure, insolvency, occurs when a firm is unable to pay its liabilities as they come due. When a firm is insolvent, its assets are still greater than its liabilities, but it is confronted with a liquidity crisis. If some of its assets can be converted into cash within a reasonable period, the company may be able to escape complete failure. If not, the result is the third and most serious type of failure, bankruptcy.
Bankruptcy occurs when the stated value of a firm’s liabilities exceeds the fair market value of its assets. A bankrupt firm has a negative stockholders’ equity, which means that the claims of creditors cannot be satisfied unless the firm’s assets can be liquidated for more than their book value. Although bankruptcy is an obvious form of failure, the courts treat insolvency and bankruptcy in the same way. They are both considered to indicate the financial failure of the firm.
MAJOR CAUSES OF BUSINESS FAILURE
The primary cause of business failure is mismanagement, which accounts for more than 50 percent of all cases. Numerous specific managerial faults can cause the firm to fail. Over expansion, poor financial actions, an ineffective sales force, and high production costs can all singly or in combination cause failure.
Economic activity, especially economic downturns, can contribute to the failure of a firm
If the economy goes into a recession, sales may decrease abruptly, leaving the firm with high fixed costs and insufficient revenues to cover them. Rapid rises in interest rate just prior to a recession can further contribute to cash flow problems and make it more difficult for the firm to obtain and maintain needed financing.
A final cause of business failure is corporate maturity. Firms, like individuals, do not have infinate lives. Like a product, a firm goes through the stages of birth, growth, maturity, and eventual decline. The firm’s management should attempt to prolong the growth stage through research, new products, and mergers. Once the firm has matured and has begun to decline, it should seek to be acquired by another firm or liquidate before it fails. Effective management planning should help the firm to postpone decline and ultimate failure.
10 common reasons businesses close their doors :
- Failure to understand your market and customers. We often ask our clients, “Where will you play and how will you win?” In short, it’s vital to understand your competitive market space and your customers’ buying habits. Answering questions about who your customers are and how much they’re willing to spend is a huge step in putting your best foot forward.
- Opening a business in an industry that isn’t profitable. Sometimes, even the best ideas can’t be turned into a high-profit business. It’s important to choose an industry where you can achieve sustained growth. We all learned the dot-com lesson – to survive, you must have positive cash flow. It takes more than a good idea and passion to stay in business.
- Failure to understand and communicate what you are selling. You must clearly define your value proposition. What is the value I am providing to my customer? Once you understand it, ask yourself if you are communicating it effectively. Does your market connect with what you are saying?
- Inadequate financing. Businesses need cash flow to float them through the sales cycles and the natural ebb and flow of business. Running the bank accounts dry is responsible for a good portion of business failure. Cash is king, and many quickly find that borrowing money from lenders can be difficult.
- Reactive attitudes. Failure to anticipate or react to competition, technology, or marketplace changes can lead a business into the danger zone. Staying innovative and aware will keep your business competitive.
- Over dependence on a single customer. If your biggest customer walked out the door and never returned, would your organization be okay? If that answer is no, you might consider diversifying your customer base a strategic objective in your strategic plan.
- No customer strategy. Be aware of how customers influence your business. Are you in touch with them? Do you know what they like or dislike about you? Understanding your customer forwards and backwards can play a big role in the development of your strategy.
- Not knowing when to say “No.” To serve your customers well, you have to focus on quality, delivery, follow-through, and follow-up. Going after all the business you can get drains your cash and actually reduces overall profitability. Sometimes it’s okay to say no to projects or business so you can focus on quality, not quantity.
- Poor management. Management of a business encompasses a number of activities: planning, organizing, controlling, directing and communicating. The cardinal rule of small business management is to know exactly where you stand at all times. A common problem faced by successful companies is growing beyond management resources or skills.
- No planning. As the saying goes, failing to plan is planning to fail. If you don’t know where you are going, you will never get there. Having a comprehensive and actionable strategy allows you to create engagement, alignment, and ownership within your organization. It’s a clear road map that shows where you’ve been, where you are, and where you’re going next.
- Lawrence, Principle of managerial finance, Fourteenth edition