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What are the common reasons why businesses fail?

5-minute read

Josh Hall

8 February 2010

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Updated for 2017

Business failure statistics in the UK are dramatic. While as many as nine in 10 businesses will survive their first year of trading, according to the latest statistics up to four in 10 don't make it to the five year mark.

It is difficult to run a business at the best of times. But as the economic outlook in the UK gets gloomier, and with both business and consumer spending at risk, it's important that small businesses take precautions to make sure they weather the storm.

Even the most profitable firms can find themselves endangered by apparently unremarkable circumstances. Awareness is vital if you are to avoid this unfortunate fate. So what are some of the most common reasons for business failure?

Reasons why small businesses fail

1. Cashflow management

Poor cashflow management is the primary reason for a vast proportion of business failures. Many profitable companies find that they are, for all practical purposes, insolvent – simply because of uneven cashflow. The key is to have enough cash coming in to meet your necessary expenditure on a month-by-month basis.

Efficient cashflow management relies on you spreading out your expenditure as much as possible, and ensuring that customer invoices are settled in a timely manner. You should decide on payment terms and uphold them strictly as far as possible; these terms might be payment on receipt, or you might give your customers 30 days to settle their accounts.

Your choice will depend, to a great extent, on the nature of the industry in which you operate. On average, businesses wait 72 days to be paid, but it's important that you have prompt payment pratices in place to help even out your cashflow.

You may also wish to investigate invoice finance products. These facilities mean that you can borrow up to 90 per cent of the face value of your invoices within as little as 24 hours. This type of lending is also valuable because your invoice finance lender can take on the task of chasing payment for you. This can all be done entirely transparently, meaning that your clients need never know you have made use of such a facility.

2. Lack of focus

Another common reason for business failure is so-called ‘scope creep’. This is a major problem in project management, but it extends to organisations as a whole.

Many firms spread themselves too thin. Presuming that operating in a large number of markets will increase their potential turnover, some business managers commit resources in too many places and on too many projects. In many cases this means that firms enter markets of which they have little or no experience, while committing less time and money to their core business.

There is nothing wrong with expanding into new markets. However, you should never enter into a new venture without the necessary expertise and resources, or without carrying out adequate market research. You should also think carefully before you commit to new projects at the expense of your core business.

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3. Tax bills

Inability to pay a tax bill is another remarkably common reason for business failure. HM Revenue and Customs will aggressively chase firms that repeatedly fail to settle their tax bills, and they will eventually petition for insolvency.

If you are an employer it is vital that you keep on top of your PAYE payments. Do not get trapped into thinking that you can spend employee deductions now and make up the difference at the end of your PAYE period – on that route lies disaster.

If you are having difficulty paying your tax bill you should contact HMRC immediately. You may qualify for the Time To Pay Scheme, which offers firms extra time if settling a tax bill would cause them significant financial problems. You should note, though, that HMRC appears to be winding the Time To Pay Scheme down and, as such, they may be less receptive to requests for help.

As a company director, you also need to remember your personal Self Assessment. In particular, remember that your bill each January will be inflated by the payment on account – make sure you plan ahead for this expenditure.

4. Lack of insurance

The correct business insurance is vital for the stability of any business. Aside from the fact that many firms have a legal responsibility to get insured, underinsured businesses run the risk of falling prey to cripplingly expensive compensation claims or repair bills in the event of trouble.

For example, a flood in your premises could damage all your fixtures and fittings, leaving you unable to open for business and with a large bill for repairs. Without the insurance to cover the cost, a new business would almost certainly be in trouble.

If you are employer you have an obligation to take out employers’ liability insurance. This will help to protect you against claims arising from injury or illness suffered by an employee in the course of their work.

Even sole traders should seriously consider taking out insurance. If you visit a client’s premises, or if they visit yours, you should invest in public liability insurance. This will pay out in the event of injury or damage to such an individual or their property. Claims arising from incidents of this sort can be easily large enough to bankrupt a small firm, and it is therefore vital that you are properly protected.

5. Reliance on small number of customers

A large number of businesses fail because they are over-reliant on a very small number of clients. It takes just one unexpected closure to result in significant financial hardship. Short-term future earnings can be massively reduced, and invoices for completed work can go unpaid.

While maintaining caution about spreading yourself too thin, as explained above, you should try not to rely on a very small client base. If you deal with a very few clients, or if a small number make up the bulk of your turnover, you should begin scouting for new work.

Business failure can be quick and unexpected. However, the bulk of failures result from poor management or a lack of forethought. Make sure that you are aware of the major risks facing your firm and you can help ensure that you are in the best possible position to avoid them.

6. Lack of planning

A business plan should be the cornerstone of any growing business, but all too often small firms either don't make one at all, or abandon it as soon as they're set up.

It's important that you have a comprehensive framework for growth, and that you are constantly referring back to it throughout the life of your business. You should be setting benchmark goals and measuring your progress against them, both with regard to your own aims and the average performance in your industry. You should also consider reviewing your SWOT analysis at regular intervals.

7. No focus on value

Unless you know where you're adding value, you can't expect your clients or customers to know either. A particularly common reason for business failure is a lack of focus on what the business does well or differently. How do you perform better than your competitors? What are you offering that your clients or customers need?

You should have a laser focus on your value proposition, and make sure that you do not lose sight of it as your business and client base expands.

8. Lack of preparedness for economic change

Finally, it's important to understand the ways in which the economy is changing, and to take steps to mitigate the impact on your business. Perhaps the most important coming change is the gradual increase in interest rates. There is growing concern that the UK's businesses are over-indebted, having grown used to a low interest rate environment. However, rates are now increasing, and it's important that you are able to continue servicing any debts you have.

This process begins with some hard sums. You should calculate what you need to set aside in order to be able to make your repayments if the rate increases by a few percentage points. This will likely involve making changes in other aspects of your business, for example in your prices, and you need to be prepared to do that in order to make sure that you are able to meet your debt obligations.

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We create this content for general information purposes and it should not be taken as advice. Always take professional advice. Read our full disclaimer

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