Why do small businesses fail?

The risk of business failure is real when running a business. Entrepreneurship is inherently risky. There are risks from starting, owning, and growing a business.

To lower the risk of business failure, it is necessary to understand what can lead to failure. When you understand the reasons why businesses fail, you are better prepared to manage each business challenge. The most common reasons small businesses fail include an inadequate business model, bad management, a lack of capital or funding, and a failed sales and marketing strategy.

How many businesses fail?

Starting and running your own business is the quintessential American dream. It goes beyond that, though. People from all over the world come to this country because they know that here anything is possible. But, unfortunately, the reality for most people who try to start a business is that the American dream ends with an American nightmare. Experts can’t agree on exact numbers, but many believe that the failure rate for start-up businesses is between 30-50% within the first few years after opening their doors. You would think that these numbers would scare away would-be entrepreneurs. But thousands of businesses are started every day.

Why such a high business failure rate?

The answer to this question is not a simple one. Various factors can determine whether or not a business will make profits and strive or fail to generate revenue and wither away. Just as no single component can guarantee a business will be successful, there’s also not one factor that can kill a business either. It usually takes a combination of errors to cause a business to fail so quickly from its inception. Knowing why businesses fail can help new business owners know what not to do. By limiting mistakes, entrepreneurs will drastically increase their chances of survival past those critical first few years of operation.

Most Common Reasons Why Businesses Fail:

Business failure and lack of business planning

When it comes to starting a successful business, the adage holds true: “He who fails to plan plans to fail.” It’s amazing how many individuals attempt to create a business without any sort of focused planning. Even though they know that the odds are stacked heavily against them, they still go at business creation with an “I’m going to wing it” attitude and then are surprised when the business crashes and burns. But business planning must go beyond just the first month, even the first year. The Japanese are masters at business planning. They typically create business plans of up to 120 years out into the future. Now that’s a “big picture” mindset. People who want to create lasting businesses should make the effort of planning it out long before they start their operations.

Businesses fail due to poor or no planning

Your business idea is more likely to succeed when you plan ahead. A solid business plan can be the beginning of a successful business journey. In addition, having a business plan will help you prepare for potential business challenges.

The business plan should include the estimated costs of bringing your product or service to the market. And it will forecast business revenues based on your sales and marketing strategy. Using the data in your business plan helps you understand when and where to spend money to establish your company. But, more importantly, the business plan will help you understand what it will take to recoup your investment.

Without a business plan, you’re going into your entrepreneurial journey unprepared. Why? Because once your business is up and running, every mistake you make could be more easily handled if you took the time to create a business plan.

Why is location so important for business success?

Having an amazing business in the wrong location will still result in business failure. No matter how good your marketing efforts are or how talented your staff is, location is critical to its success for most businesses. You can have the best-tasting soup shop in the country, but your chances of success will be much higher in the right location than it would be in the wrong location. The location of the business is one of the most important and influential decisions a new business owner can make. It should not be done without much research and thought.

The importance of location in a business

Business location has everything to do with success. The business location has a huge role in attracting customers, staff, and business partners, all of which are critical for business success.

The location of a business can boost its profitability, market share, and overall competitive edge. Good location decisions can boost a business’s performance, but poor ones result in a business failure.

For example, a company can decide to relocate to a less expensive location to cut costs. But, the new location could result in loss of customers and staff members—causing business failure.

Lack of capital: A common reason businesses fail

Most novice business owners severely underestimate the amount of capital needed to successfully start and run a business. As a result, businesses take a little bit of time to get situated and turn a profit. What happens is that many businesses run out of operating capital prematurely and are forced to close their doors. Since the business is new, getting the financial backing of a lending institution can be difficult, especially in the current state of the economy. People wanting to beat the odds should overestimate what they believe they will need in operating capital.

How does lack of capital cause business failure?

Your business depends heavily on its ability to sell products, get paid and meet obligations to reload your inventories, expand and grow your business. However, within this interdependent chain are factors that threaten your ability to meet future obligations and lead to business failure. Therefore, your current assets must be greater than your current liabilities to build up your working capital.

Unfortunately, a component of your current assets is your accounts receivable. When you work with customers who are slow payers or out of cycle with your accounts payable or bills you pay, you wind up with an unsustainable cash flow situation over time. Having several months of cash available to you to fund those gaps in funding would be ideal for most businesses. However, when you cannot access funding resources like those traditionally provided by banks, your business suffers.

Why does bad marketing result in business failure?

A business is destined to fail if it doesn’t do a good job attracting customers who need and can purchase its products and services. Too many individuals think that once the doors open for business, a flood of paying customers will find them. This idea is so very faulty. Businesses that succeed rarely do so because of luck. It takes savvy and hard-working business owners with a keen mind on marketing to creatively and affordably generate consistent new business. Fortunately, marketing techniques and strategies can be learned and implemented quickly. Those business owners that want their business to thrive long-term need to create marketing systems that will continue to attract new customers to their doors.

Marketing is the heart of business, and no business can achieve success without it. Unfortunately, both big and small businesses can fail due to poor marketing. Unfortunately, too many businesses fail because they don’t create a marketing plan that leads to growth.

Instead of creating a research and data driven marketing plan, they rely on gut feeling. Unsurprisingly, the result is often business failure. For example, a business might spend weeks debating the right color scheme for a website but fail to optimize for sales conversions.

Here’s what you need to do to avoid business failure due to marketing mistakes:

  • Don’t try to sell to everyone, marketing cannot target the world. Good marketing starts with understanding the target customer. Only market to your ideal customers.
  • Set measurable marketing goals. How will you know if your marketing is a success if you cannot measure it?
  • Don’t ignore your competition. Pretending that your competitors don’t exist could lead to business failure. If you pay attention to the competition, you can find important information to help you succeed.
  • Don’t copy the marketing strategies of your competitors. Instead, learn from your competition. Analyze their marketing systems. Then, create a marketing plan that is superior.
  • Implement a systems-based marketing strategy. A marketing system helps you repeat what works and avoid what doesn’t, it’s the only way to avoid business failure.
  • Build on facts not “gut feelings.” Don’t make any marketing decisions without hard evidence.
  • Create a marketing strategy with the customer in mind. Understand their needs, wants, and fears. Don’t reject customer feedback if you want to avoid marketing failure.
  • Every marketing tactic should have measurable goals. Measure success based on your goals. Make adjustments as you learn what works and what fails.

A business with low-profit margins will fail

The lower the margin of profitability a business has, the greater the likelihood that it will fail. If it takes $1 to produce $1.50 in revenue, the business is at severe risk of falling apart the first time trouble hits. Compare this situation to a business where each $1 is producing $10 in revenue. The latter business has much more room to deal with the financial hiccups that inevitably occur with new businesses. If you want a business that will be strong enough to survive the storms of the first few years of operation, make sure that you have large profit margins. But, can a profitable business fail?

Why do profitable businesses fail?

Profitable businesses fail for many reasons. But, the most common reason a profitable business fails is for underestimating the critical importance of cash flow to the success of a company. Some businesses are more vulnerable to cash flow problems than others. For example, companies that accept net-30, net-60, or net-90 payment terms can fail even if otherwise highly profitable.

A company that relies on delayed payments can quickly run out of cash, causing business failure. No amount of future profits can make up for the lack of cash flow because it forces companies to spend money they don’t have. And the result is a failed business due to running out of cash.

Although many businesses fail, this doesn’t mean that yours needs to. Knowing the most common pitfalls in failed business attempts will guide you through creating a business that can outlast the norms. Running a successful business can be the most exciting and rewarding experience that you can have. But it can also be a nightmare filled with stress and financial disappointment. Proper planning is the cornerstone of all strong businesses.

How to turn around a failing business?

Although every business failure is a different situation, there are common steps to take to turn around a failing business.

Turn around a failing business with a business plan

No business should be started without a business plan. The same is true for turning around a failing business. If you want to save a failing business, you should start with a business plan.

The employees, management, partners, and investors will need to see your plan for turning around your failing business. You need to share your vision for turning around your failing business. If you have a plan, they can help the company succeed.

Include the mistakes of the past and what must happen to avoid the same mistakes. Then, if you run the business based on the business plan, it is much less likely to get into trouble.

Cut costs to turn around a failing business

Cost-cutting is a great way to turn around a business. Cutting expenses may seem impossible at first but with a little practice you can quickly reduce business expenses:

  • Renegotiate your lease or move to a less expensive location.
  • Only allow essential spending. Cut all discretionary spending from your business.
  • Find a less expensive credit card processing service. Get several bids and ask for an easy-to-understand breakdown of costs. Banks are experts at creating confusing service agreements.
  • Buy in smaller quantities and for lower prices. Renegotiate lower prices with vendors. Be upfront with your vendors and partners about the need for cost-cutting to save your business, you might be surprised how many will lower prices.
  • Use equipment for longer before replacing it. And when it’s time to buy equipment, buy used.
  • Sell what you don’t use. Do you have any equipment that you don’t need? Sell it. Do you have unused office space? Sublet unused space to another business. Don’t pay for real estate you don’t need. Do you have office furniture or computers that you don’t need? Sell it to make more cash for your business.
  • Cut employee hours, perks and benefits, if it will help turnaround your business. Also, cut management pay.
  • Lay off employees and work with freelancers as needed.
  • Cut back on insurance expenses. Renegotiate rates or get bids from other insurance companies.