What are the top causes of business failure?

By Alan Johnston July 01, 2014 Full Credit

“Grow in haste, repent at leisure” – wise words. Indeed it is when we move from a transition period of stagnation into a growth phase that businesses are most at risk of failure.

Why? Because growing a business requires capital funding and too often we see businesses endeavouring to expand their activities without paying attention to the working capital they have available to finance that growth.

Commonly referred to as “growing too quick too soon” or over-trading, it is this combination of rapid growth and insufficient financial resources which causes a large percentage of the business failures we currently see. And this at a time when a buoyant market suggests businesses should be prospering.

Too often companies expect that growth can be achieved without the need to inject more capital into a business.

Sometimes it is perceived that by using rising debt levels with merchants and suppliers, and taking advantage of extended repayment terms – either formally, or informally – the business can remain viable and solvent.

This brings me to the aspect of solvency. There are two “tests” that measure a business’s solvency.

  1. Does the value of the assets exceed the value of the liabilities?
  2. Is the business able to pay its debts as they fall due?

It is this latter test that businesses often fail to satisfy, and this can bring about their downfall. After all, the process of liquidating a company can be quite a straightforward procedure for a creditor, and not overly expensive.

Creditors can prepare their own Statutory Demand and deliver it at no cost, so this is an attractive and powerful tool for the person seeking payment of their debt.

Starplus Homes, which went into receivership, and liquidation, in April of last year was a classic example of a company which may well have been able to satisfy the first solvency test (although asset values are always open to conjecture) but struggled with the latter, which ultimately contributed to its downfall.

 

AVOIDING THE OBVIOUS CAUSES OF FAILURE

Of course, the above is only one cause of business failure, albeit one of the more common within the building industry.

Nick James, American business commentator and renowned authority on the subject, in an article entitled “What they don’t teach you about business failure at Harvard or Oxford”, once listed the top causes of business failure as:

  • Putting the product first, marketing second.
  • A bad business partnership.
  • A business model which is too complex.
  • Attempts to pioneer a new product or industry.
  • Legal claims.
  • Personal relationship failure.
  • An over-emphasis on image.

Our own research into the building and related industries here in New Zealand enabled us to come up with the following list of reasons for failure:

  • Growing too big too soon (lack of working capital).
  • Lost income/bad debt on a job or contract (often emphasising the importance of using the Construction Contracts Act effectively).
  • Poor costings and a lack of back costing.
  • Poor financial management (not understanding the difference between cash flow and profit).
  • A reliance on future income to pay past debt.
  • A relationship or business partnership breakdown.
  • Poor marketing.
  • Taking on more than you can chew/getting away from what you know.

More simply though, I believe business failure can be put down to three key causes:

  1. Bad luck – which you can do little about.
  2. Bad faith – which you can try and minimise the risk of.
  3. Bad management – which you can do something about!

So, by focusing on situations and experiences that have come about through what could be termed “bad management”, we can hopefully learn from their mistakes.

To sum up, what are the key learnings?

  1. Improve cash flow management (plan for the worst; use cash flow reporting; retain funds / working capital in the business).
  2. Keep communicating with your stakeholders.
  3. Stick to what you do best.
  4. Don’t be afraid to have a good hard look at your business.
  5. Be good at what you do!

At the end of the day, wouldn’t it be disappointing to have navigated through the Economic Ice Age of the last few years, to trip at the last hurdle?

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Alan Johnston is General Manager, CreditWorks Data Solutions Ltd, and has been involved in credit management for over 35 years. In 2011 he was presented with the NZCFI Credit Professional of the Year Award, for his achievements within the credit industry. Email him at alan.johnston@creditworks.co.nz or call him on 09 520 8133 to find out more.

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