Why Businesses Fail

"Up to ninety per cent of businesses fail in their first five years of operation" The first time I heard this was many years ago during an accounting seminar. At that time, it sounded rather unbelievable; however, I now believe those statistics are true and probably higher or occur within shorter time spans, especially during times of global economic stress.

The Cause of Business Failure

Of course, many people have now heard of these facts, but what most unsuccessful business managers do not know, or fail to pay attention to, is why their businesses fail. The statisticians say that the reasons are quite simple: inappropriate or lack of necessary marketing programs, and/or inappropriate or lack of necessary accounting systems. That's it! It doesn't matter whether you are the owner or Chief Executive Officer, you need to understand the financial requirements necessary to successfully manage your business.

The basics of accounting systems are elementarily simple. All you need to know is the real purpose of your financial reports and how to use them to accurately assess your business's performance - past, present and, most importantly, for the future.

Personally, I believe the underlying issue why businesses fail is cashflow! Or rather, lack of it. Obviously, this should be all wrapped up with having the appropriate accounting systems to run your business, but I have only seen one organisation that successfully used their accounting systems to manage their cashflows efficiently. So efficiently in fact, that they effectively turned their whole multi-national organisation from near collapse to their recorded profits in only three years. So what is the secret behind ensuring longevity and profitability for your business? Once again, the answers to life's most difficult questions are often simple - and typically obvious. Cash! Glorious, glorious cash. Cash is real. Cash is tangible.

The value of cash is known and reliable. Cash is liquidity and liquidity means having the flexibility to be proactive in your business affairs. Cash enables you to become proactive rather than reactive to economic crises. Most failing businesses have forgotten the importance of cash.

I'm not talking about just the physical paper, but more importantly, how much cash you have in the bank at the end of the day. Too many businesses have gone broke when their financial reports have told them they were profitable - on paper! Cash makes the world go around. Cash makes your business safe. Cash helps you to plan for your future; and cash will help your business expand safely. But first, let us return to the concept of business failure. In precise terms, a business fails when it ceases trading and leaves unpaid obligations. This may be due to voluntary business wind-up, or voluntary or enforced liquidation or bankruptcy. Yet, nevertheless, the failure is due to unpaid obligations. So, what causes the failure? Simple, isn't it? Lack of cash in the bank at the end of the day.

Avoiding Premature Demise

The enemy of businesses is debt overload. If you are the owner or CEO of a business you must keep a close watchful eye on your finances. Do you know how much debt your business will carry - this month, three months, one year and five years into the future? Do you know how much funding you will need to maintain or expand your stock levels, open a new store, or manufacture a new product - this month, three months, one year and five years into the future? Do you know what your outstanding creditors will be - this month, three months, one year and five years into the future? Do you know what your outstanding debtors will be - this month, three months, one year and five years into the future? And do you know how much cash you will have in the bank - this month, three months, one year and five years into the future? If you cannot answer 'yes' to all of these questions, don't worry: you are in the majority. Most companies cannot answer 'yes' definitively to all of these questions, but these companies are probably also in great risk of going broke in the next five years - or at least having to suffer that devastating and stressful daily existence of operating from cash flow crisis to cash flow crisis.

The American Statistical Association has stated: "A cross-sectional analysis of all trading suspensions that occurred during the period 1974-1988 in the New York Stock Exchange reveals that, though the desire to maintain price continuity remains an important motivation to suspend trade, inventory-imbalance fears are pronounced for large firms."

From the Editor of Inc.com we are reminded: "There are a few simple steps you can take to make sure your business avoids a premature death. First, find someone willing to pay for your product or service. Second, hoard your cash. In the words of one successful entrepreneur, 'Throw nickels around like they're manhole covers'."

And from BusinessWeek: "Once a new company is up and running, the most obvious cause of failure is simply running out of money. Experts call undercapitalization a symptom of poor planning, however, rather than a true cause of failure.

Yes, planning. Planning, planning, planning. You have probably heard it over and over again. Planning for your business, planning for research, planning for expansion. Marketing planning, recruitment planning, sales planning. On and on, we go. But do you do sufficient cash planning and do you know anytime during the next five years where your cash ebbs and flows will be? Not just approximately, but all planned out - on paper, on graphs? Does your accounting system produce reliable financial reports that connect your sales levels with your stock levels and your profits to your cash at bank? Do you assess your business's performance by profits on paper - or cash at bank?