Why Do Small Businesses Fail?

Nov 1, 2021

There is nothing like the excitement of starting your own business and being your own boss.  Branching out on your own can be extremely rewarding however, it can also bring many challenges from a financial and operational perspective. In fact, according to data from the U.S. Bureau of Labor Statistics, approximately 20% of U.S. small businesses fail within their first year.  By the end of their fifth year, the failure rate climbs to 50%.  And after 10 years, only a third of small businesses have survived.

These certainly are not the most favorable statistics and while there are numerous reasons why the success rate is low, we’ll focus on some of the primary factors that we’ve seen lead to failure, and offer up some great ideas and solutions on how your entity can remain viable.

Cashflow – is probably the single biggest reason for business failures.  Simply put, the lack of cash and liquidity to pay for materials, supplies, labor, and daily operational expenses can be devasting.  Cash is the life blood of any entity and having enough of it, especially during the early stages of a business while sales and profits are still gaining momentum is critical to an entity’s success.   As such, business owners should strongly consider monitoring cash on a weekly basis, utilizing projections for inflows and outflows, to identify any shortages or gaps where financing may be needed, or if expenditures need to be reduced or delayed.  In addition, accounts receivable should be aggressively monitored to ensure a steady stream of cash is being collected.  It’s also important to have a solid working relationship with your bank and to take a proactive approach with them when needing financing, rather than waiting until the last minute when it may be too late.

Lack of Profitability – entrepreneurs are creative, passionate, and most are good at the “selling side” of the business.  However, if a business doesn’t know its costs, or does a poor job of estimating and accounting for all direct and indirect costs of running the business, profitability will suffer.  As such, business owners should take a realistic approach to carefully research and accurately estimate the costs of their products and services as well as all indirect, general, and administrative expenses.  From there, pricing and profit margin decisions can be made considering market conditions and competition.  Resources at local Small Business Centers as well as CPA’s can assist with this exercise to ensure profitability is not an issue from day-one.

Inventory Control – once an entity has begun production, it is important to monitor demand and match it with production.  Nothing is worse than having a stockroom full of goods that are simply not selling, and as over-production of a certain SKU can create an unnecessary gap in the sales cycle, and the sales velocity of all products should be closely monitored.  In addition, careful consideration should also be given to how entity’s order raw materials and merchandise them for resale.  While it may be great to receive quantity discounts on bulk orders, the offsetting cost of storage and impact of having an inordinate amount of cash tied up in inventory should also be considered, as over-ordering can create many unwanted issues.

Lack of Market Research – while it’s great to have a new idea, product, and/or service, careful market research should still be performed.  In short, you have to know what your customers want as there are countless instances where entrepreneurs have gone into the market thinking they have the next great service or product to offer, but they fail to realize that nobody wants or needs it.  By doing your homework and researching your market, you will know exactly how to meet your potential customers’ needs.  In addition, many entrepreneurs start a business that targets too wide of an audience of potential buyers.  In our experience, this is a risky approach that generally doesn’t work out too well as sellers waste time and valuable resources chasing consumers that have no intention of ever buying their product of service in the first place.  Rather, we suggest a more targeted and narrowly defined approach to finding your “niche” market and then focusing efforts on the “right” audience.

There are numerous other factors that can contribute to business failures however, we feel the aforementioned areas are some of the most critical aspects that new business owners should focus their attention and resources on.  In addition, it’s critical that new business owners recognize when they need help, and it is strongly encouraged that they not wait too long to seek or request assistance.  The good news is that there are numerous resources such as the Small Business Association (SBA), local small business programs offered by community colleges and of course, professionals in the financial and accounting industry that are dedicated to helping small businesses succeed.

For more information on how DHW can assist your small business with getting started, mitigating risk, and ensuring viable operations, please contact Tim Reynolds at 828.322.2070 or at tim@dhw.cpa.