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Why Do Small Businesses Fail?

General Business News

October 2012

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Why Do Small Businesses Fail?

According to the U.S. Small Business Administration, more than half of entrepreneurships fail within the first five years of existence. Former small business owners cite a litany of reasons why their business didn’t make it, usually ranging from complaints about banks and the government to their allegedly incompetent partners. Although some of these reasons are legitimate, most small business failures are caused by a lack of planning and focus on the part of the owners – despite the fact that there are many experienced professionals willing to provide assistance.

The most common cause of small business failure is the market, or more specifically, the lack thereof. Surprisingly often, would-be entrepreneurs do not perform enough research to ensure that there is ample demand for their product or service at a price that will create a profit. It is vital that they test the market for their products before losing their savings in a doomed enterprise. Prospective entrepreneurs should start slowly to develop as much certainty as possible that their product will sell and their business will succeed.

Starting slowly is a valuable mantra that also exposes another reason why small businesses fail: excessively rapid expansion. Successful businesses that try to maintain a breakneck growth rate can quickly develop growing pains. Owners become overwhelmed and a once-profitable business becomes damaged by expanding too rapidly into unprofitable markets or taking on too much debt.

Borrowing too much money can also exhaust a new business’ cash cushion. Especially in the early stages of an enterprise, having cash on hand for unforeseeable events can often make the difference between success and failure. Businesses are cyclical, so there will always be up times and down times, but small business owners need to be able to survive the unexpected – a natural disaster, a lawsuit, the introduction of a competitor or the loss of an important customer or employee.

Small business owners also need to control their costs. Materials, software, wages, rent and state and federal taxes take an often underestimated bite out of profits. A solid business plan with realistic cost estimates can help put a new business on the path to success. In today’s business climate, lean companies are at a distinct advantage. The failure to negotiate good terms with suppliers and plan for cost overruns can leave a small business uncompetitive.

Another extremely common reason for small business failure is poor accounting practices. Many entrepreneurs are completely unprepared for the time and effort involved in tracking the income and expenses of their business. Invoices need to be sent out in a timely manner and accounts payable and receivable must be tracked meticulously. In addition, state and federal tax authorities require quarterly tax payments. Many entrepreneurs are unskilled accountants, mistakenly believing they can perform these tasks on their down time or on weekends. Such administrative tasks are not only essential for a successful business, they are also extremely time-consuming. New small business owners often become overwhelmed soon after starting business operations, but finances are ultimately the most important part of a new business. Not only does routine accounting have to be taken care of promptly, but the business needs a financial vision as well – a big-picture viewpoint that sheds light on the months and even years ahead. Many entrepreneurs are reluctant to seek professional help, mistakenly believing that they have to do it all themselves.

Another unfortunate reason for small business failure is the lack of a succession plan. What happens to the business if the owner gets sick or incapacitated? Are suitable replacements available for valuable managers, or will people be thrust into positions for which they are not prepared? Without a well-defined succession plan, power struggles and nepotism can quickly doom an otherwise successful business.

Small businesses fold for many reasons, but entrepreneurs who fail with one business actually have substantially increased chances of success on their next try. They learn valuable lessons about the importance of planning and focus and they realize their weaknesses, contracting with experienced professionals for assistance in helping make their business profitable. Successful entrepreneurs know that getting professional help in running a new business greatly increases their chances of survival.

Seek help from a financial advisor to get your business plan in good working order. He or she will be able to provide you with specific details about your business’ situation. With the right advice, you will be able to develop a small business that thrives.

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These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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