Reasons for Business Failure

Causes of Business Failures

Causes for business failures can be grouped into two main categories: financial causes and non-financial causes (Figure 1).

Fig. 1 - Reasons for business failures

Financial Reasons for Business Failure

From a financial perspective, business failures often arise from poor cash flow management and a lack of working capital.

Poor cash flow management

Positive cash flow happens when cash inflow is greater than cash outflow. By contrast, negative cash flow occurs when cash outflow exceeds cash inflow.

Negative cash flow is the main cause of small and medium-size business (SMEs) failures.²

Timing is extremely important in cash flow management. If cash outflow takes place before cash inflow, the business will experience a shortage of cash.

To have enough capital to meet expenses, companies need to make sure that their cash inflows take place in a timely manner. For example, there should be no late payments from customers.

Insufficient working capital

Insufficient working capital happens when the current assets are less than the current liabilities.

One major component of a company's current assets is accounts receivable, or money yet to be paid by the customer for a good or service. Having too much overdue in account receivables can put a business at risk since it no longer has enough cash to cover daily expenses.

To buffer against delayed payments, businesses should have several months of capital in reserve. A company can raise capital from various sources such as owners' own savings, family and friends, angel investors, venture capitalists, crowdfunding, or financial institutions.

For instance, an angel investor is an individual who offers funding for new businesses, often in exchange for shares in the company. Similarly, venture capitalists, often individuals employed by a financial firm, offer funding for startups in exchange for shares. On the other hand, crowdfunding is the accumulation of small donations (often online) from a large number of individuals to raise money for a new business.⁵

Non-financial causes

Non-financial causes of business failure can come from inside or outside the firm. These causes may include:

Poor management

Inside the firm, poor management is a major cause of business failure, as it can lead to:

• Low morale - Employees may experience unfair treatment or a lack of work/life balance and opportunities to grow, which dampens their motivation to do their best and in return help the company grow.

• Decreased productivity - The lack of clear expectations and appreciation can deter employee productivity and lower the company’s revenue.

• Reduced profit — Bad management might misuse the business's capital, which can lead to financial struggle.

External shocks

Outside the firm, external shocks - such as natural disasters, pandemics, financial crises, and technological, legal, or political changes - may occur.

Business Failures Types

Business failures can be classified into three types:

Unavoidable business failures

Unavoidable business failures are caused by unpredictable changes such as natural disasters, pandemics, wars, recessions, political or legal changes, etc. While there's no way to avoid these unfortunate events, companies can come up with a crisis management plan in advance to reduce their damage.

Predictable business failures

Predictable failures are failures a business can predict in advance and prepare to overcome. For example, a business can avoid product launch failure by doing market research and targeting the right group of customers. A company's historical data, such as market share, revenues, and profits, can be used to predict future crises.

Intellectual business failures

Intellectual business failures arise from experimenting with new products or strategies. For example, a company invests a lot of money in new technology but fails to generate revenue from it. This type of business failure often occurs in innovative businesses such as tech or medical companies.

Examples of Business Failure

Here are some real-life examples of business failures:

Failure due to pandemics

Friska is a series of successful restaurants in the UK that were shut down by the Covid-19 Pandemic. Previously, the company had managed to acquire up to 3 million in funding for expansion. However, the abrupt pandemic and strict lockdown regulations forced the restaurant chain to close all its locations from April 2020. Despite an enormous effort to sustain the business, the company closed down in July 2021.⁶

Failure due to a shortage of capital

Berg was a UK-based tech company that had come up with many revolutionary design ideas in the tech space such as Twitter Bird House, Google Desktop, and Little Printers, a cloud-based printer that allows you to print things from social media and the web. Sadly, the company was forced to close due to a lack of funding in 2014.⁷

Failure to external shocks

Igloo Energy was a gas and electricity supplier in the UK. Its customer base averaged 179,000 people throughout the country. Once a successful and popular business, the company was forced to close in 2021 due to the skyrocketing wholesale prices of gas and electricity.⁸

As you can see, there are many potential causes for business failure, both financial and non-financial. While some are unavoidable, others can be predicted and prevented. Before you go, let's have a look at some key takeaways.

SOURCES

1. Rob May, ‘A Start-ups across UK are going to bust - They need more careful-management for our economy’, The Telegraph, 2019, telegraph.co.uk.

2. Nia Williams, ‘SMEs’ most common issue is cashflow’, UK Tech News, 2019, uktech.news.

3. Conor Cawley, 'The ‘8 out of 10 Startups Fail’ Statistic Is a Myth’, Tech.co, 2019, tech.co.

4. Liz Rosling, ‘Cash Flow Statistics UK 2021 – Need To Know Business Figures’, SMS Loans, 2019, smeloans.co.uk.

5. Patrick Henry, ‘What are the Typical Startup Funding Rounds?’, Medium, 2016, medium.com.

6. Mark Taylor, ‘It’s really difficult' - Friska founder gives update as Bristol cafes remain closed’, Bristol Live, 2021, bristolpost.co.uk.

7. Mark Wilson, ‘Pioneering Design Consultancy Berg To Shut Down’, Fast Company, 2011, fastcompany.com.

8. Nick Duffy, ‘Igloo Energy goes bust with 179,000 customers moved to a new supplier as small providers continue to struggle’, inews UK, 2021, inews.co.uk.