Why businesses fail – and how to avoid it?

Why businesses fail – and how to avoid it?

Despite our best efforts, we can fail. Business failure isn’t common, but it can lead to a lot of debt, heartache, and soul-searching.

According to the Australian Securities and Investments Commission, 7,498 companies went insolvent over the Financial Year 2018-19. That’s out of 2,313,291 businesses total (2018, Australian Bureau of Statistics.) It seems like a small number; but it seems to happen more often to smaller businesses. 76% of reports concerned companies with fewer than 20 employees.

85% of failed companies had estimated assets of about $100,000 or less, and 38% had estimated liabilities of $250,000 or less. 62% of companies had an estimated deficiency of $500,000 or less.

Those who fail to heed history end up repeating it. What are the major causes of business failure in Australia, and how can you as a business owner avoid it?

51% – Inadequate cash flow or high cash use

Cash flow is the lifeblood of any business. Your business needs cash flow to not only survive but thrive. Savvy CEO and business finance expert Bill Tsouvalas tells us that deficiencies in cashflow can be shored up with lines of credit and other types of finance. “Having lines of credit or loans is an effective and sound method of ensuring adequate cash flow, especially if your business is out of the start-up stage.

“Sending out an invoice and waiting 30, 60, 90 days until payment can put a real strain on cash flow. Using invoice finance to get paid now and putting the cash to use immediately can help with easing pressure from creditors and fund current liabilities such as payroll.”

If your business isn’t large enough for invoice finance, using automated financial software to keep on top of late invoices can help get cash flowing. Other ideas to improve cash flow are to offer discounts for early payment or liquidating old stock.

43% – Poor strategic management

Sometimes businesses forget to see the forest for the trees when it comes to their strategic financial management. Expanding too quickly, tying cash up in the wrong places, and having a lack of direction can cripple a business. Even though strategic management is the watchword here, it all comes back to how well you handle cash.

Using short term cash flows to fund long-term assets is another way business runs into trouble. If your company is contemplating purchasing a large asset such as a car or equipment, you’ll need to think strategically. Using cash usually set aside for immediate inventory purchases to acquire assets used over an extended period (usually years) will mean your short-term cash is tied up in long-term assets. The opposite is true: using long-term loans to pay for short-term liabilities can also cause trouble. Paying off these assets using future income over time is a more manageable way to conserve cash flow.

Learning to read financial statements and keeping focused on the bottom line – profit – is how to keep a business sustainable. Remember: having ample cash on hand does not necessarily mean a business is profitable.

39% – Trading losses

Trading losses are the next biggest cause of business failure and can sometimes be caused by failing to understand pricing, customer needs, and underestimating the cost of business. Undercutting a competitor’s coffee by 10c per cup may net you more business in the short term but will sink your company through sustained losses.

Can you turn things around?

Unless your company is on the verge of going into administration, businesses can often be turned around. It all starts with keeping detailed records and looking at the data to come up with an action plan.

Don’t look to your accountant for advice: your accountant is only keeping score, not kicking goals. If your business is consistently in the red, you need to analyse your numbers and see where things are underperforming.

The leading contributor to business failure is ignorance. It might feel a bit painful, but knowing where you’re at means you can start to correct course and become profitable again.