Why Businesses Fail

There have been many attempts to define what makes businesses successful; unfortunately no one has found the secret formula to guarantee success.  Certainly there are some common traits among high-performing businesses such as passion, vision, and unique marketing position.  However, the jury is still out about what exactly will ensure market domination and long-term success.
Luckily, there has also been a lot of research done on why businesses fail, and here there does seem to be a far more quantifiable theme.  Research done by Seattle-based Business Resource Services (BRS) indicates that approximately 60 percent of all new businesses will disappear within the first three years, and 90 percent in the first 10.  This doesn’t necessarily mean that they all went broke; many business owners will have simply given up because it’s all too hard, and gone back to working for someone else.  Others will have been taken over by their competitors, moved into other markets, etc., but the cold hard statistics are still very sobering for anyone considering venturing into the heady world of business ownership.
This same research has found that 90 percent of business failure can be attributed to faulty management—more particularly, poor financial management.  If we can avoid these seven deadly sins, we may not entirely avoid the risk of failure, but at least we can maximize our chances of success.

Here are the primary financial killers of business:
1.    Failure to plan properly before startup (otherwise known as errors of omission).  This  involves getting your structure right, having access to adequate capital, knowing your market, and determining your human and physical resource requirements—all of the things that a good business plan should tell you.  The good thing about not planning, however, is that failure comes as a complete surprise, and isn’t precedented by a period of worry and depression.
2.    Failure to monitor financial position.  Developing a profit plan and cash flow budget, and the monitoring performance to determine variance.  Looking at ratios and benchmarking to determine stability and efficiency, both against industry figures and your own targets.  Remember, if you’re not doing so well and the rest of your industry is, chances are it’s your fault.
3.    Failure to understand the relationship between price, volume and costs.  Understanding how each of your expense categories varies with sales so you can accurately determine your contribution margin and break-even sales.
4.    Failure to manage cash flow.  There is an old accounting saying that profit is a matter of opinion, but cash is reality.  If you can’t manage your cash flow to maintain your liquidity, it doesn’t matter how profitable you are, your creditors will simply shut you down.
5.    Failure to manage growth.  Growth is good but it can also bring you down if it isn’t controlled.  It never ceases to amaze some people that the majority of businesses that go broke each year are actually both highly profitable and successful.  They simply grow too fast and therefore run out of the ability to fund the uncontrolled expansion.
6.    Failure to borrow properly.  The golden rule of borrowing is to match the terms of the loan with the life of the asset.  Even bankers will agree that the worst product they sell is an overdraft, and yet many business owners put their cash reserves at risk by using this facility to make major capital purchases.  Dealing effectively with banks and other finance institutions is critical to success.
7.    Failure to plan for transition.  For most owners, there are only three ways to get out of their businesses when they are done with it: sell it, shut it down, or give it away (usually to your kids). With the emerging demographic bubble as the baby boomer generation approaches retirement, and the majority of owners seeing their business as a major component of their retirement income, planning your exit strategy early will become crucial.  Potential investors will target well-managed, systemized businesses that do not rely on the current owner for their continued success.
As I said before, there is no magic formula for success, and avoiding the above will not necessarily guarantee you achieve it, but it at least gives you the best chance of realizing your personal and business goals.

Reprinted with permission from Australian Flower Industry Issue 17, December 2007.

Geoff Butler


Geoff Butler is the principal of Business Optimizers, a business advisory practice assisting small and medium business owners.
Contact him at [email protected]