Why Do Small Businesses Fail?
Feb 24, 2021 by Roger Scherping
No one likes to think about failing. We start our businesses with optimism, enthusiasm, and perhaps a level of confidence that comes from the fact that we don't really understand just what we’re getting ourselves into. Well, we all know how we learn by making mistakes, but it’s far better to learn from other people’s mistakes. So I searched the Internet for the reasons why small businesses fail. Here’s what I found.
Guidant Financial lists five reasons why small businesses fail. Their article points out that 20% of new businesses fail in their first year, and 50% fail by the end of their fifth year. That sounds scary, but in my experience a failure rate that high is caused by the fact that the owners are missing badly on some of the basics. Just a little bit of research will tell an entrepreneur some key steps that they really must take if they want to succeed. In other words, overlook these basics at your own peril!
1. Starting With Too Much Debt
Borrowing heavily to start your business will result in a high debt load and high monthly payments. A new business must generate enough cash to pay for its operations and its debt. If the business doesn’t reach positive cash flow quickly, it may never be able to pay off its startup debt. The article suggests looking at more creative financing options, like 401(k) business financing. And, of course, bootstrapping the business yourself, if possible, is the best way to avoid debt.
2. No Business Plan
I know how you feel about writing a business plan. You think it’s long and tedious and won’t really help you once you launch the business. Wrong! A solid business plan will ensure that you’ve thought through everything about your business – from products to pricing to financing – before you launch. Don’t forget that your business plan also includes detailed financial projections.
3. Mismanaged Cash Flow
Anyone starting a business had better learn how to manage cash flow. You need to be aware of what’s coming in and what’s going out. Speed up the former, and slow down the latter! Don’t forget to plan for payroll. Project your cash flow far ahead – 4 weeks out in detail at a minimum, and 6-12 months out at a high level.
4. Ineffective Leadership
Leadership starts at the top. In my experience as a small business consultant, I see all kinds of small business owners. The best ones are willing to admit they don’t know everything and are willing to let go. They have no problem turning the details of their business over to their employees. An effective operating system like the Entrepreneurial Operating System (EOS) allows small business owners to let go and have confidence that their employees are being held accountable and are sticking to the owner’s vision.
5. Failure to Adapt
2020: Do I need to say any more than that? The small businesses that survived in 2020 adapted and changed. Some of my clients even thrived in 2020 because they stayed flexible and adapted to those most unforeseen circumstances.
Inc. magazine also lists five reasons why small businesses fail. Their list is centered around marketing, customers, and your market:
1. Failure to market online.
2. Failing to listen to their customers.
3. Failing to leverage future growth.
4. Failing to adapt (and grow) when the market changes.
5. Failing to track and measure your marketing efforts.
Investopedia lists four reasons why small businesses fail. All of these reasons overlap the two previous lists.
1. Financing Hurdles
This one is a combination of Starting with Too Much Debt and Mismanaged Cash Flow above. Having adequate working capital is critical. So is understanding your pricing. You wouldn’t believe how many small businesses I’ve seen where they are so unaware of their costs that they didn’t even realize that they were selling their products at a loss!
Entrepreneurs need to understand their numbers before they launch their new venture. They need to do a 2-year financial projection that shows them that they can make a profit, that their business can afford to pay them what they need, and how much money they need to get started. Confidence comes from understanding your numbers.
Existing small businesses also need to understand their numbers. Small business owners need to know where their business will be at financially in the next 12 months. They need to know the lowest their cash will get, whether they will be able to afford a significant capital expenditure, and whether a business expansion makes sense financially.
2. Inadequate Management
This one is similar to Ineffective Leadership and Failure to Adapt above. Good leaders build a strong team. It is the only way to be successful.
3. Ineffective Business Planning
Good leaders also make business planning a regular part of their routine. So write that business plan, and then keep it updated! Do not put it on the shelf and forget about it. We like to say that business planning is not something that you do once. It’s something that you do once a month! Here is a link to our RAAP Sheet to help you review and plan every month. Regular business planning is the best way to ensure that you stay on top of your business, pricing, and markets and that you continuously adapt to changing conditions.
4. Marketing Mishaps
This one includes every marketing oversight mentioned in the Inc. list above.
We created ProjectionSmart to help entrepreneurs and small business owners.
Startup is for entrepreneurs. Do your Finances First TM! Complete a 2-year financial projection for your new business concept before you launch. You need to make sure your concept makes sense financially, and Startup is the easiest way for someone without a background in finance or accounting to do that. Once your numbers make sense, then use our Proof Plan TM to create a full business plan. Writing a business plan using the Proof Plan is easy because we focus only on the aspects that are most important to bankers and investors.
Growth is for existing small businesses. Growth makes it easy for someone without a background in finance or accounting to see their financial future. In less than an hour you can do a 12-month financial projection for your business. You’ll be able to see trouble well ahead of time so that you can react now, before it’s too late.
Let us know if we can help you with your startup or small business.