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Causes of Business Failure

The following are some possible causes of business failure.

• Cash flow problems
• Poor business planning
• Fall in demand for the product
• Rise in costs or a lack of control of costs

We will give a brief overview of each.

Cash Flow Problems

For many small and newly formed businesses, this is often the single most important reason for business failure. The problem arises when the money coming into the company from sales is not enough to cover the costs of production. It is important to remember that it is a case of having the money to be able to pay debts when the debts are due, not simply generating enough revenue during a year to cover costs.

Cash is regularly flowing out of the business but not very often flowing in. If the business does not manage this carefully, it can find itself in difficulties and facing insolvency.

Some firms have periods of time when they do not receive much revenue - a good example is companies who make toys. The peak times for toy sales is November and December - it may be that 80% of all the revenue it receives in a year is received during these two months. The firm does, however, have to survive for the rest of the year - it will have staff, rent, insurance, taxes, energy and so on to pay for as well as costs incurred in manufacturing products throughout the year.

For some hints on how to prevent cash flow difficulties, follow this link from Bytestart - Top Tips for keeping cash flowing.

Poor Business Planning

Many new businesses will have to put together a business plan to present to the bank before it receives loans or financial help. The time and effort put into these plans is crucial for success. Bad planning or poor information on which the plan is based is likely to lead to difficulties for the firm. For example, if the firm plans to sell 2,000 units per month in the first year because it used only limited market research and ends up only selling 500 per month, it will soon be in serious danger of collapse.

Fall in Demand

There are a number of reasons why demand might fall. Some of these might be to do with the business taking their eye off the ball and not paying sufficient attention to their customers' needs - perhaps the product is not up to scratch, perhaps the quality is poor, maybe the price is too high - most of these things are within the businesses control.

Falling sales might be a sign that there might be something wrong with the product or the price or some other aspect of the marketing mix. Sometimes the fall in sales might be as a result of the competition providing a better product or service - in part the business can do something about this they have to recognise it in the first place.

Changing tastes, technology and fashion can cause demand for products to fall - the business needs to be aware of these trends. Copyrights: Emin Ozkan and Yaron E, both from stock.xchng.

Demand might fall for other reasons not in the firm's control. It might be due to a change in the economic climate of the country. If the economy is experiencing a downturn then maybe people may not have as much money to spend on the businesses products or services. The Bank of England may have increased interest rates and this has led to people cutting back their spending.

Other factors might also lead to a fall in demand - the product may have gone out of fashion, maybe people's tastes have changed - all of these things could be an explanation. The important thing for a business is to try and recognise when demand changes and to understand why it is changing. If it does not then it can be too late and the business may fail.

Rise in costs or lack of control over costs

Costs of production can rise for a number of reasons. There may have been wage rises, raw material prices might have increased (for example the price of oil or gas), the business might have had to spend money on meeting some new legislation or standard and so on. In many cases, a firm can plan for such changes and is able take them into account but if the costs rise unexpectedly, this can catch a firm off guard and tip them into insolvency.

Many firms have many costs in producing their product - a rise in these costs or failure to control them can lead to problems. This firm might be affected by a rise in steel prices for example! copyright: Wena, from stock.xchng.

Some firms face difficulties because they do not keep a close eye on their costs. Wastage in the workplace is a good example of this. Every piece of paper, every nut, bolt, screw, light left on, tap left dripping and so on represents a cost to a business. If it does not keep control of these costs, the problem can get worse. Staff using telephones to make personal calls, sending e-mails that are nothing to do with the business, wasting paper or leaving PCs switched on all might be areas where a business might want to exert some control to keep costs controlled.

Task

The two companies below have experienced problems and have been closed down in the last two years. They are well-known companies, and in both cases, a rescue package tried to help revive them, but they have now ceased to exist in their original form.

What do think were the causes of failure in each case?

• Rover cars
• Golden Wonder crisps

Golden Wonder crisps have been around for many years - why do you think they failed? Copyright: Christian MacDonald, from stock.xchng.

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