Most businesses which fail do so because they run out of money. External events such as a fire or a legislative change which takes away a market may result in businesses failing but these are very rare occurrences and by far the most common reason for failure is lack of money.
However this simple statement itself masks a myriad of factors. Lack of cash or insolvency can be the result of among other things a prolonged period of inadequate sales; a major bad debt; excessive level of debt that cannot be serviced; overstocking; overtrading and undercapitalisation. Each of these is a separate issue which can affect the new business as well as the established business but the common result is insolvency and failure of the business.
The most obvious cause of business failure is of course lack of profitability because the level of sales which can be achieved has no possibility of covering the business’s costs. It is not however necessarily the most common cause of failure. Profitable companies with good order books often fail.
Overtrading is a common reason for failure and happens when a business tries to trade at a level it cannot support with working capital. The business is unable to fund the level of stock and debtors needed meet its order book and as a result is unable to pay its suppliers, employees etc and insolvency results.
A major bad debt is another common cause of failure in profitable businesses and is obviously a serious risk factor for businesses which have a small number of large customers and businesses which carry an excessively high level of debt are particularly vulnerable to failure because a small reduction in the level of activity can mean that the costs of servicing the debt places intolerable strain on the business.
Overstocking occurs when a business ends up with excessive stock which it is unable to convert into sales and income. This may be the result of poor stock management; purchasing stock in anticipation of a contract which doesn’t materialise or the loss of a major customer. If the extent of the overstocking is substantial insolvency may be the result simply because too much of the business’s cash is tied up in unsaleable or low value stock.
Whilst any one of these events may trigger the failure of a business quite often a combination of circumstances will combine to tip the balance. So overtrading and excessive debt may reflect the fact that the business was not properly capitalised from the outset and a substantial bad debt which on its own may not be sufficient to cause insolvency may result in overstocking as a result of stock having been purchased for the major customer.
The fact that there is no single cause for business failure means that it is impossible to establish an immutable business law for survival. The fact is that any sort of business venture involves risk of failure but it is possible to identify key factors and activities which have a fundamental impact on a business’s chances for survival and to develop strategies to significantly improve a business’s prospects.
The key factors are: cash; assets; debt and funding and control.
This an extract from one of a series of articles written by Barry Minnery covering good business practice