Reasons why small businesses fail

“Happiness is a positive cash flow”

For small business owners, cash flow is the lifeblood of the business and maintaining a healthy cash flow is as critical to them as breathing. Needham says that the minute a business starts to struggle with cash flow, the red flag immediately goes up. Typically, if a business falls behind on their payments it either means one of two things: they went into the business undercapitalised, or they confused revenue with profit.

Linda Finch, an accountant with Fletcher Tax Accountants is of the opinion that going into a business undercapitalised and then spending like there is no tomorrow is one of the worst mistakes a first-time operator can make. “First year businesses often go out with a ‘spend, spend, spend’ attitude. They neglect to think about how each expenditure is going to benefit their business. Like renovating a house ready for sale, a dollar-for-dollar return is often not achieved.”

The misconception that many first-time operators often make is that if they have enough money to put themselves into the business in the first place, then they will easily be able to maintain and grow that business. Unfortunately this is not always the case, something Michael Dempsey, managing director of Ezidebit and former small business owner, found out the hard way. “They [the business owner] might have gone into the business fully stretched,” he explains. “They had enough money to put themselves in the business, but once the business is up and running they find their debts have started to blow out by 90 days. They are not getting money into the business, so all of a sudden they are stretched for cash and can’t pay their immediate debts.”

Business broker Greenup says inexperienced operators often confuse revenue with profit, particularly in the early stages. He gives the following example: “Say the business owner has $20,000 per week coming into his/her bank account, $2,000 of which might be eventual profit, but he/she spends as though the $20,000 is his/hers. It actually belongs to the suppliers, landlords, utility companies and staff, then he/she gets what is left over.” Greenup says that business owners can often get excited when the first lot of money comes pouring into the business and they act like a kid at Christmas. “If a new business owner has been used to budgeting $1,000 per week wage then suddenly gets $20,000 a week; without any solid systems to know how much is actually theirs to keep, it is like having a free credit card,” he explains. “Then reality catches up with them and the business is on the defensive for months, recovering from the initial euphoria of having substantial early positive cash flow.”

Cash flow can make or break a business and is a crucial element of the business mix that cannot be ignored.

“Business has only two functions – marketing and innovation”

Marketing plays a critical role in any business and, if done incorrectly, can cause permanent damage to the business’ brand and reputation. When the question “why do small businesses fail?” is asked, the first thing that comes to mind is troubles with cash flow. Without money there is no business, right? But marketing can be just as important. It’s one thing to have a product, but if you can’t successfully market that product and convince your customers to buy it, there will be no money to flow into the business.

Any business owner will tell you that customers are the most important part of the marketing mix; a fact to which Wong from Catalogue Central can attest. As the CEO of successful online catalogue business Catalogue Central, Wong has achieved 80 percent year-on-year growth since launching in 2006, simply by listening to his customers. “Know who your customers are and what they want from your service,” he suggests. “At Catalogue Central we simplified things for the customer. They were running around trying to find specials online, searching through a million different websites. We made it easy for them by giving them access to all the information they need in the one place.”

Cat Matson, director of client development for consulting firm Alito, puts it down to the fact that many businesses don’t understand the importance of a strategic approach when it comes to marketing, and therefore often take a ‘hit-and-miss’ approach. “I see many clients who say ‘look, we’ve done all this advertising and it’s not working’, and when I look at their advertising I can see why. It is not strategic or consistent. They haven’t sat down and talked about who they are targeting and why.”

According to Usher from Action Coach, it is important to always be one step ahead of the game and to change up or add value to your offering. “I witnessed two examples of recruitment companies trying to stay relevant during the crisis. One did not diversify its services and as a result had to close down its door. The other saw the economic situation was changing so they diversified. They knew people would be getting rid of their HR managers, so they became the external HR managers as well as the recruitment, and they thrived.”

“Be the captain of your own ship and the master of your destiny”

There are many reasons why small business operators will fail within the first few years; so many, in fact, that it is hard to touch on all of them. However, the most common causes of failure stem from the fact that operators lack the experience or knowledge to run a business and therefore neglect to undertake basic tasks such as writing a business plan and having a good set of financial figures. They have trouble implementing proper business systems and fail to keep them up-to-date, which then impacts their cash flow.

The road to success is never going to be a smooth one, so the key is knowing how to navigate over the bumps.

  • Dan

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  • The overall point of your article is that the business owners have far more control over the success of their businesses than they think. If they follow common sense business practices, like what you mentioned, they will undoubtedly succeed. Good for you for alerting business owners that they can successful when they take control.

  • Jessica,

    Thank-you. A great article, for all small biz owners; I thoroughly agree with Andrew Needham statement

    “Often we see businesses that are in need of an accounting system so they go buy a copy of MYOB off the shelf and then that’s it. But they hardly ever use it or keep it up-to-date,” he says. “They start to fall behind on their GST reporting and it becomes a much bigger issue in relation to cash flow management.”

    MYOB can produce many of the reports that biz need for their decision making process, but many don’t get it set up properly, don’t get training in how to use it, and don’t look at it on a regular basis.

    Look at your numbers, even if they are not good, look at them. You can’t run a business without understanding cash and if you are not controlling that, you are not moving forward.

    Follow me on twitter @myobtrainer

  • Great article, my advice would be to start a business part time and see how that goes before you expand and make it your only source of income. Ending up with a loan that you need to repay when teh busines closes could set you back years. Best to start slowly.

  • Good article.
    I’d like to add that before starting a small business an entrepreneur should access his/her potential, make business plan, see how much risks are involved and most importantly can he/she survive without earning or profit for two to three years i.e. has enough capital?

    Generally people think that own business means RAINING DOLLARS. Yes it is, but it takes some time with your commitment, time and patience then prosperity comes.

  • The key that a lot of people don’t realise is that things don’t happen overnight, or without a great deal of input, and starting a new business can often result in 70+ hour work weeks for a year or more before you are sufficiently able to cut back without the business suffering. It all comes down to knowing those numbers in the end as you just don’t know what you need to do without them!

  • Reports from the Small Business Administration (SBA) find that “2/3 of new employer establishments survive at lease two years, and 44 percent survive at least four years.” This is a far cry from the previous long-held belief that 50 percent of businesses fail in the first year and 95 percent fail within five years.”

  • You made some good points there.I did a search on the topic and found most people will agree with your blog.

  • Great article, my advice would be to start a business part time and see how that goes before you expand and make it your only source of income.

  • Generally people think that own business means RAINING DOLLARS. Yes it is, but it takes some time with your commitment, time and patience then prosperity comes.

  • ben ryan

    i liked this website a lot madi also liked it and we thought it would be a great way to start our business