As many as half of all businesses fail in their first three years of trading, this factsheet summarises the specific reasons for business failure and how to avoid them.
Here are the reasons for business failure. If you are considering, or have recently started a business in the Essex area we, at SKZ Chartered Certified Accountants, can assist you in developing management information so that you can avoid many of the reasons for business failure.
As many as half of all businesses fail in their first three years of trading. A contributor to ensuring business success and avoiding failure is to know your enemies.
Generally the main reason for the high failure rate of small newly established businesses is when the owner lacks experience in managing all aspects of the business. Interestingly, new businesses appear to survive better in economic downturns than older more established businesses. This may be because they are more adaptable to change, or possibly perhaps they were set up in the recession and therefore were not surprised by the sudden weakening in trading conditions.
There are many more specific reasons for business failure.
Common reasons cited by many owner managers for business failure
Increased competition from larger businesses
Competition from larger businesses can cause problems as they make use of their size and buying power to reduce costs and therefore selling prices to levels which smaller businesses simply cannot compete against.
As a small business, one of the best ways to protect against this threat is to carry out industry research to ensure that you know who your competitors are, what size they are in relation to your business, and what support network they have, such as whether they are part of a large group.
As a business owner, you need to identify the threats that competitors pose to your business and try to mitigate those threats by developing your strengths against the weaknesses of the competitor.
For example, a small local grocery shop may be under threat from a large supermarket chain opening a store on the edge of town. It would be unrealistic to consider trying to compete on price so the grocer needs to differentiate their business from that of the superstore by building on the strengths it has, such as:
- focusing on local produce from local suppliers
- offering a personal service and knowing customers and their families by name
- introduce a local delivery service where goods can be ordered by phone rather than online
- order in specific goods for customers with special requirements.
Lack of sales
A lack of sales is not only a particular problem for a new business but can also apply when new product lines or services are introduced in existing businesses.
Carrying out market research will help to eliminate as many problems as possible in the early stages. By researching the target market and local conditions, inappropriate products or incorrect pricing should be identified and corrected before, or soon after, the business commences.
Market research is an expense which many business owners try to avoid, but it can provide valuable information and prove to be cost effective. It may even be possible to conduct your own market research surveys rather than paying an expensive agency to do it on your behalf.
For example you could visit local businesses which you may want as your customers to canvass opinion on your product, or if your target market is made up of consumers, you could survey shoppers in the local town centre.
Gaining credibility for a business venture can be extremely difficult and so market research is important to assist in obtaining finance for the business.
To protect your business against loss of customers, you should try to have a mixed range of customers, in different industries and avoid over reliance on just one or a few key customers. By doing this, your business will be naturally protected against one customer going bust, or a dip in a particular industry.
Failing to keep up with technological advances in your market can also lead to lack of sales, as your business loses out to more up to date products sold by competitors. It is imperative to stay up to date for the sustainability of the business unless you choose to operate in a specialist niche market, which may have a finite life or limited market.
Poor cashflow is a key problem for many owner managed businesses as many owner managers tend to have good knowledge in their field but little experience of managing other aspects of the business, including cashflow.
It is important to ensure that the business has enough working capital to meet day to day cashflow requirements.
Day to day cashflow can be improved by:
- making sure the business is not carrying too much stock, particularly old or slow moving stock
- having disciplined credit control procedures to chase up overdue debts
- undertaking credit checks on new customers before offering credit facilities.
Common reasons cited by many professional advisers for business failure
Lack of monitoring of performance and results
Many small businesses do not prepare management accounts, so the only time they review the results of their business is when the year end accounts are prepared, which is typically at least six months after the year end. Year end accounts do not carry much detail which means that the business is often lacking in detailed information. Consequently a business cannot use this for comparisons to actual and expected performance.
All businesses should carry out reviews of their results periodically during the year, and compare the actual results to last year and expected figures. This will help to identify any potential problems so that corrective action can be taken on a timely basis.
Turnover instead of profit led
It is easy for business owners to focus on sales growth and be over optimistic about the level of sales which can be achieved, especially in the early years. Very few such entrepreneurs actually have any solid facts behind their projected turnover figures. As previously mentioned, market research is very important to ensure that the expected market share is realistic.
Many business owners also tend to focus on trying to increase sales, instead of focusing on controlling costs and increasing profits.
As a business owner you must put together a proper budget to ensure that all costs are covered. Typical errors made include setting sales prices based on the direct costs of the product and not including any of the overheads of the business such as rent and rates.
Preparing an annual business plan to include a forecast profit and loss account can help to identify all potential costs to ensure they are considered when calculating selling prices. This will also give you a valuable measurement tool to compare with the actual performance of the business.
Taking too much out of the business
Some business owners like to take large amounts out of their business, either by way of drawings, salaries, bonuses or dividends. If your business is struggling it may be worth reviewing personal drawings and reducing them for a short period, to help the long term viability of the business.
It is better to have lower income from a sustainable business than higher income over a short term.
Some businesses struggle to meet their tax liabilities on time. The Business Payments Support Service provided by HMRC allows a business to negotiate ‘time to pay arrangements’ across the various taxes. However, this service is only offered to businesses who are likely to be able to pay their tax liabilities if they are given more time to pay and not to those which can no longer feasibly pay at all.
Therefore, if your business is struggling to meet its tax liabilities, it may be worth contacting the service to see if you can agree a time to pay arrangement before matters reach a crisis level.
Management skills are necessary to develop a strategy and to train and manage people. Owner/managers are usually specialists in the product and services their business offers, so issues are dealt with on a day to day basis.
These individuals often have a passion for their business however they may not possess expertise in the area of management and, as a result, long term planning is neglected. It may be worth investing in a training session or online course to develop management skills to obtain the best results from your staff.
A happy, motivated workforce can drive the success of a business.
It is especially important to have the right people in key roles within your business, so you must consider how to retain them within the business over the long term.
Every business should also have a ‘succession plan’ in place to cover roles if a key person leaves. This helps the business to survive when it loses a key member of staff, whether permanently or temporarily if for example, they are off sick for a long period.
If a business is being run single-handedly by the owner/manager, you should have a succession plan and insurance in place in case of personal emergencies.
Small businesses often do not have the necessary in house expertise to ensure compliance with legislation for issues such as employment law, health and safety law and environmental standards.
Complying with all the legislative requirements can be a major problem for the small business. Form filling and staying up to date with all of the changes is unlikely to be a priority for the owner, and yet it is essential if the business is to survive and continue successfully. Occasionally new legislation can remove a market or actually make it too costly to continue to serve it.
This can lead to costly consultancy fees for the business. Unfortunately, it is difficult to avoid these fees for complex issues.
There are government agencies which offer free, impartial support to businesses, such as Acas which offers advice regarding employment issues. Health and safety information can be found on the internet and consultants may only be needed if trading in a high risk environment.
The choice of location can have a big influence on your business. If your business depends on customers visiting the premises, it must be based somewhere which is easily accessible for customers, and not somewhere which is too remote or in a bad area. If the business depends on passing traffic, such as a shop, it must be situated somewhere with a lot of people passing on foot or with easy parking.
Finance and business plans
It can be difficult to obtain financing for a business or even to keep your existing facilities.
When applying for finance it is very important to submit a business plan to demonstrate the viability of your business and lend credibility to your application. This business plan should include forecast financials (profit and loss account, cashflows) as well as market research backing up your sales figures.
Even if you do not require finance, it is a good idea for any business to prepare a business plan. This will give the business a strategic direction and something to monitor actual results against.
Planning is extremely important. It can be said that ‘failing to plan, is planning to fail’. The business plan should include external and internal issues to see if the owner/manager can cope with the potential ‘worse case scenario’ that could arise. Comprehensive discussions with an adviser can prevent (or at least highlight) a wide range of problems and methods of minimising or overcoming their impact.
When things go wrong
It can be extremely difficult and traumatic to face up to the failure of your own business. Many owners are tempted to bury their heads in the sand and hope that things will somehow improve. However, the best way to get things to improve is to face up to the fact that the business is struggling as soon as possible – the earlier you identify there is a problem, the earlier you can take remedial action to try to save the business before it is too late. If you think that your business is struggling, seek help and advice immediately.
How we can help
There are undoubtedly many advantages to securing business success.
We are able to assist you in the areas where businesses generally fail and assist in ensuring that you have the right mix of skills suitable to making your business a success.
We can assist with preparing management accounts, cashflow forecasts and finance and business plans and, if things go wrong we can assist with remedial action.
If you are considering, or have recently started a business in the Essex area and you would like to discuss these procedures any further please contact us at SKZ Chartered Certified Accountants.