Why do Businesses Fail?

It’s a sad fact that businesses fail everyday as they run out of cash, potentially leaving the directors exposed to criticism and even to disqualification proceedings. This article looks at how and why businesses get into real cash flow difficulties and how the real way to avoid any chance of appearing on the directors’ disqualification register is to avoid business failure in the first place.

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People sometimes talk about businesses burning through money and in truth business failures can be like fires. Something smouldering can be difficult to spot at first, but could easily and safely be extinguished before too much damage is done. Once there is a real blaze, the danger is much more obvious, but at the same time much more difficult and dangerous to tackle as it consumes everything around it.

As the old saying has it, cash is king. And no one believes this more firmly than turnaround professionals. Because fundamentally businesses fail when they run out of cash. So a real cash flow difficulty is a real threat to your business’s very existence that calls for immediate action.

The four types of business failures

Many failures are start ups that simply do not survive their first few years, either because they found there was really no market for what they were doing or because with the limited resources available to a start up they were unable to surmount a problem they encountered.

Having got through these critical early stages however, business that fail then fall into three main categories.

While they can be high profile, catastrophic failures where a business suddenly ‘falls off a cliff’ are actually quite rare and are usually due to the impact of some traumatic event such as a major fraud, lost litigation or sudden change in regulations, although some might say that management should have been looking out for these problems in advance.

By contrast, overtrading, where a business grows too fast for its available finance, is a relatively common cause of failure in boom times and a particular problem as an economy comes out of recession.

But most ‘normal’ failures follow what is known as the business decline curve, where an underperforming business becomes firstly distressed, and then as the decline steepens, falls into a cash crisis and ultimately failure.

How do you spot the warning signs before real cash flow difficulties?

If a business is on the decline curve, it can be difficult to spot it at first but then the further down it goes, the more its problems compound as it descends the slippery slope.

An underperforming business will make less profits than its competitors, even if only marginally at first. But with less profits it cannot reinvest as much into the business in new products or the latest plant and machinery. Slowly it will start to slip behind and as it loses its competitive edge its market reputation and share will also fall, until it sees its first losses.

Funding losses soon starts to eat cash and so a distressed business attempts to stretch and juggle its cash. The bank soon notices the state of the overdraft and wants security and personal guarantees, particularly if it finds the company is submitting management accounts later and later as it doesn’t want to show the bad news. Payments to suppliers and subcontractors become further and further behind and as staff realise the problems, morale and the quality of work sinks.

As the crisis bites and CCJs begin to arrive, the finance director jumps ship or goes off on long term sick leave. The company is on stop from its suppliers and sub-contractors are walking off jobs so it cannot get the materials needed to produce goods for sale and so collect in cash.

And then suddenly it’s all over as the business cannot pay the rent or the wages at the end of the month and has to cease trading.

What causes normal business failure?

Normal businesses failures seem to involve some mix of five main contributing factors.

1 Management problems which can range from autocratic dictatorships that won’t listen to any view but their own boards riven by disputes or a lack of appropriate management skills lower down in the business. These sorts of management problems are crucial since it is normally these that hold a business back from dealing with the other problems facing it.

2 Failure to deal with strategy challenges, which are an inevitable fact of life for any business as its markets, customers and competitors constantly develop and change.

3 Lack of financial control, so that you do not really know where your cash flow is being choked, which products and customers are profitable and which aren’t, or even whether you are actually making money at all.

4 Lack of operational control, so that you are making the most efficent use of either your hard assets of plant and machinery and your soft assets of people and processes.

5 Big projects which can disrupt business and take up cash and management time, such as a new computer system, a problem acquisition, a huge new contract or a move, as these can prove to be the straw that breaks the camel’s back.

So if any of these signs seem at all familiar you should seek professional advice from an accredited turnaround professional with experience in dealing with these types of situations. That way you won’t have to worry about the Directors’ Disqualification Register as you will never have to go near it.