Why businesses fail and why your management accounts can prevent this happening
Like a post mortem, an investigation into the causes of the death of a business always attracts a lot of interest. The most immediate cause is that the business has run out of cash.
You can have it all:
- Great product
- Highly motivated and energised team
- Rising sales
- Smart business premises
- A Queen’s award for industry
… but you run out of cash. Insolvency Practitioners see this pattern all the time as the internal blame game starts, together with the pointless debate of distinguishing cause from effect. So let’s dig a bit deeper …
Causes of running out of cash
At the heart of business failure is frequently the failure of management to understand the financial dynamics of their own business. There is a wilful failure to engage with “the figures” believing that “this is what the accountant does, it’s nothing to do with me”. This failure manifests itself in:
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- Lack of knowledge as to the company’s most profitable products/services and concentrating on them.
- Overtrading – going gung ho for sales growth, forgetting that higher sales invariably requires higher working capital (stock and debtors) and these can be very cash hungry.
- Poor or non existent management accounts. Relying on your annual accounts – available anything up to 18 months after the problems start – will mean you respond to problems too late.
- Poor stock control (i.e. you have too much of it to service your sales).
- Poor credit control allowing customers to treat you as a secondary bank.
- Working too hard in the business and paying insufficient attention to keeping the future sales pipeline flowing.
Certain factors appear time after time:
Bank Managers are taught from day 1 that “management” is at the heart of every lending decision and is the main factor in determining whether or not the bank gets its money back. The life of a business manager consists of making thousands of decisions – some trivial, some matter and small number are critical. The successful managers get the great majority right and avoid the last category altogether.
No matter how successful your business, the march of technology is inexorable and sooner or later, someone will invent something better and your business will start to decline. This is particularly true of “fashion” businesses, not just clothing or shoes, it applies particularly to restaurants and it goes without saying that toys, sports, fitness related businesses are in a daily fight for survival.
Keep re- inventing your business or sooner or later someone will do it for you, get there first and edge you aside.
The saddest business failures relate to those unfortunates who spend years developing a marvellous product, which “works” but which for some reason just doesn’t gain sufficient traction to generate enough sales to create a sustainable business. It could be down to price, it could be that the product is excellent, but that existing alternatives are “good enough” or it could be that the cost/benefit thinking behind every “buy” decision just isn’t strong enough.
Whatever it is, try not to invent something like this and spend vast amounts of time, effort and money on a great product that people simply don’t want (in sufficient numbers).
The common thread in running through all these explanations is having high quality management information to tell you how well (or badly) the business is performing. Not having up to date and accurate management information and;
- You won’t recognise the signs of failure quickly enough and take early corrective action
- Management will make one too many wrong decisions
- Change will happen too late, too slowly or not at all
Take an interest in your own business, get involved in the figures, understand them and what the implications are. And you might (just) survive!
Know your numbers and you’ll understand your business – not knowing them is the most common reason why businesses fail! Genuine management accounts provide clarity but only if you genuinely understand them so get an expert to support you and provide the advice.
Knowing why businesses fail is easy, prevent your own failure with knowledge.
Now you’ve read our article on why businesses fail – have you any more questions?
Here at Yorkshire Powerhouse, we’re happy to help as much as possible – is there anything else we can do to help you, do you have any further questions or can we help introduce you to an expert – please let us know:
Do you know why you are making a profit (or a loss?) - An advice article explaining why a simple set of management accounts will give you the answer! Read >