Business failures are a fact of life in all segments of the economy for all types of businesses. There are many reasons to explain business failure – usually excuses that blame external factors or circumstances beyond the business owner’s control.
But careful analysis points toward some commonalities in failed businesses. Knowing why other companies fail may help you avoid similar problems in your company.
Failure often results from a lack of preparation and foresight about potential dangers down the road rather than just bad luck alone. These dangers include:
1. Improper Budgeting
It’s a problem often attributed to managers with poor business acumen in the weaker economy. The reality is that many businesses fail due to overspending, particularly when they gamble on expansion or new product lines. They ignore their existing markets and contracts. As a result, they can’t generate enough profit from their large investment quickly enough to pay for it all. In time the debt becomes insurmountable.
Many huge businesses have met their demise or suffered greatly because of this. One of these is Forever 21.
One of the most popular fast-fashion brands, it filed for chapter 11 bankruptcy in September 2019. Although the cause is both complicated and deeply rooted (e.g., power struggle even within the family), a part of the reason for its downfall is overexpansion.
It opens too many big-floor stores in malls that receive lesser foot traffic. Consumers now prefer to shop online. It didn’t help that it spread itself too thinly across many demographics, while consumers’ taste has changed from fast fashion to sustainability.
In the end, the revenues weren’t enough to cover the debts. The company also failed to downsize fast to avoid bankruptcy and eventually restructuring.
2. Inadequate Financing
Another common reason for failure is being undercapitalized. A company needs sufficient capitalization from the start of operations to finance working capital, at least a year’s worth of expenses set aside for unforeseen costs and emergencies, and some reserve cash available until sales are made and accounts receivable are collected. The company also has to have the cash flow to meet its payroll and other fixed expenses such as rent or mortgages.
Many still seem to confuse profit and cash flow, not realizing that both don’t share the same meaning. In fact, a business can still declare a profit and still have negative cash flow. In other words, there’s still not enough cash to service the debt or even set up a contingency fund.
Fortunately, businesses can explore a lot of ways to increase both. For example, they can improve their collection processes to reduce accounts receivables and increase cash on hand. They can also sell underused or old assets in favor of new ones, which can boost productivity. Lastly, businesses, especially growing ones, can benefit from financial teams like JMG Solutions Experts that can offer leaders financial direction and focus.
3. Failure to Plan for the Future
Some business owners are so busy trying to sell their goods and services that they neglect planning for key elements of their business, including marketing, product selection, purchasing, logistics, and supply chain management.
This can be a costly mistake during tough economic times. For example, many companies failed in the aftermath of 9/11 because they had no adequate disaster recovery plan in place, leaving them unable to continue operations. Others may realize there is not enough demand for their products at the moment but will not consider an alternative market until it’s too late.
In the tech world, both Blackberry and Nokia fit the bill here. These brands used to lead the smartphone industry until Apple released the iPhone and changed the ballgame. Unfortunately, Nokia and Blackberry took a while before they got the hint that consumers want iPhone’s features. Instead, they preferred to stick with their old formulas, which had stopped working a long time ago.
These factors don’t mean to say that the failure of a business is its fault. External reasons can still cause it. For example, during the height of the COVID-19 pandemic, about 33 percent of businesses closed down. During the Great Recession, at least 1.5 million went under.
Moreover, many of these reasons can be overcome by revising current business practices or adjusting financial forecasts. A strong company with good leadership ability may fail due to an unexpected event in the economy. But when looking at common factors in business failures, it’s clear that developing sound strategies and implementing them effectively will make any company more likely to succeed.