Select your language

Suggested languages for you:
Log In Start studying!
StudySmarter - The all-in-one study app.
4.8 • +11k Ratings
More than 3 Million Downloads
Free
|
|

All-in-one learning app

  • Flashcards
  • NotesNotes
  • ExplanationsExplanations
  • Study Planner
  • Textbook solutions
Start studying

Reasons for Business Failure

Save Save
Print Print
Edit Edit
Sign up to use all features for free. Sign up now
Business Studies

In 2019, The Telegraph reported that up to 20% of 660,000 UK start-ups did not make it past their first year. Of those who survived, 60% were expected to fail within three years1. As you can see, running a business is not easy. Very few companies can last and make a sustainable profit in the long run. So, let's take a closer look at business failure and its main causes.

Meaning of Business Failure

A business fails when it can no longer make a profit or generate enough revenue to cover its expenses.

Business failure happens when a company ceases to operate or starts losing a lot of money.

There's often a high rate of business failures among startups due to lack of managerial experience and intense competition.

Causes of Business Failures

Causes for business failures can be grouped into two main categories: financial causes and non-financial causes (Figure 1).

Reasons for business failure, StudySmarterFigure 1. Reasons for business failures - StudySmarter

Financial Reasons for Business Failure

From a financial perspective, business failures often arise from poor cash flow management and a lack of working capital.

Poor cash flow management

Cash flow is the net balance of cash moving in and out of your business. When cash moves out of your business, it is called cash outflow. When cash moves into your business, it is referred to as cash inflow.

Positive cash flow happens when cash inflow is greater than cash outflow. By contrast, negative cash flow occurs when cash outflow exceeds cash inflow.

Negative cash flow is the main cause of small and medium-size business (SMEs) failures.2

According to a Bloomberg report in 2016, 8 out of 10 entrepreneurs failed within 18 months of operations due to cash flow problems3. In addition, the lack of capital left 38% of small businesses in the UK unable to pay off debts.4

Timing is extremely important in cash flow management. If cash outflow takes place before cash inflow, the business will experience a shortage of cash.

To have enough capital to meet expenses, companies need to make sure that their cash inflows take place in a timely manner. For example, there should be no late payments from customers.

Insufficient working capital

Working capital is the capital used in the day-to-day operations of a business, calculated as current assets minus current liabilities.

Insufficient working capital happens when the current assets are less than the current liabilities.

One major component of a company's current assets is accounts receivable, or money yet to be paid by the customer for a good or service. Having too much overdue in account receivables can put a business at risk since it no longer has enough cash to cover daily expenses.

To buffer against delayed payments, businesses should have several months of capital in reserve. A company can raise capital from various sources such as owners' own savings, family and friends, angel investors, venture capitalists, crowdfunding, or financial institutions.

For instance, an angel investor is an individual who offers funding for new businesses, often in exchange for shares in the company. Similarly, venture capitalists, often individuals employed by a financial firm, offer funding for startups in exchange for shares. On the other hand, crowdfunding is the accumulation of small donations (often online) from a large number of individuals to raise money for a new business.5

Non-financial causes

Non-financial causes of business failure can come from inside or outside the firm. These causes may include:

Poor management

Inside the firm, poor management is a major cause of business failure, as it can lead to:

  • Low morale - Employees may experience unfair treatment or a lack of work/life balance and opportunities to grow, which dampens their motivation to do their best and in return help the company grow.

  • Decreased productivity - The lack of clear expectations and appreciation can deter employee productivity and lower the company’s revenue.

  • Reduced profit — Bad management might misuse the business's capital, which can lead to financial struggle.

External shocks

Outside the firm, external shocks - such as natural disasters, pandemics, financial crises, and technological, legal, or political changes - may occur.

The Covid-19 (Coronavirus) pandemic which started in 2019 has forced many businesses to close due to lockdowns and a sharp decline in sales.

Business Failures Types

Business failures can be classified into three types:

Unavoidable business failures are caused by unpredictable changes such as natural disasters, pandemics, wars, recessions, political or legal changes, etc. While there's no way to avoid these unfortunate events, companies can come up with a crisis management plan in advance to reduce their damage.

Predictable failures are failures a business can predict in advance and prepare to overcome. For example, a business can avoid product launch failure by doing market research and targeting the right group of customers. A company's historical data, such as market share, revenues, and profits, can be used to predict future crises.

Intellectual business failures arise from experimenting with new products or strategies. For example, a company invests a lot of money in new technology but fails to generate revenue from it. This type of business failure often occurs in innovative businesses such as tech or medical companies.

Examples of Business Failure

Here are some real-life examples of business failures:

Friska is a series of successful restaurants in the UK that were shut down by the Covid-19 Pandemic. Previously, the company had managed to acquire up to 3 million in funding for expansion. However, the abrupt pandemic and strict lockdown regulations forced the restaurant chain to close all its locations from April 2020. Despite an enormous effort to sustain the business, the company closed down in July 2021.6

Berg was a UK-based tech company that had come up with many revolutionary design ideas in the tech space such as Twitter Bird House, Google Desktop, and Little Printers, a cloud-based printer that allows you to print things from social media and the web. Sadly, the company was forced to close due to a lack of funding in 2014.7

Igloo Energy was a gas and electricity supplier in the UK. Its customer base averaged 179,000 people throughout the country. Once a successful and popular business, the company was forced to close in 2021 due to the skyrocketing wholesale prices of gas and electricity.8

As you can see, there are many potential causes for business failure, both financial and non-financial. While some are unavoidable, others can be predicted and prevented. Before you go, let's have a look at some key takeaways.

Reasons for Business Failure - Key Takeaways

  • Business failure occurs when a company can non longer generate efficient funds to cover its daily operations.

  • The causes of business failures can be split into financial and non-financial categories.

  • The financial causes can include cash flow problems and inadequate capital to sustain the business.

  • The non-financial causes stem from a lack of proper management or significant external shocks.

  • There are 3 main types of business failures: predictable failures, unavoidable failures, and intellectual failures.


SOURCES

1. Rob May, A Start-ups across UK are going to bust - They need more careful-management for our economy’, The Telegraph, 2019, telegraph.co.uk.

2. Nia Williams, SMEs’ most common issue is cashflow’, UK Tech News, 2019, uktech.news.

3. Conor Cawley, 'The ‘8 out of 10 Startups Fail’ Statistic Is a Myth’, Tech.co, 2019, tech.co.

4. Liz Rosling, Cash Flow Statistics UK 2021 – Need To Know Business Figures’, SMS Loans, 2019, smeloans.co.uk.

5. Patrick Henry, What are the Typical Startup Funding Rounds?’, Medium, 2016, medium.com.

6. Mark Taylor, It’s really difficult' - Friska founder gives update as Bristol cafes remain closed’, Bristol Live, 2021, bristolpost.co.uk.

7. Mark Wilson, Pioneering Design Consultancy Berg To Shut Down’, Fast Company, 2011, fastcompany.com.

8. Nick Duffy, Igloo Energy goes bust with 179,000 customers moved to a new supplier as small providers continue to struggle’, inews UK, 2021, inews.co.uk.

Reasons for Business Failure

Business failure occurs the company can non longer generate sufficient funds to cover its daily operations. A business failure can happen as a result of poor business management, lack of demand for the product or external shocks. 

Business failure can happen as a result of financial or non-financial causes. The financial causes involve cash flow problems and insufficient funds to meet the ongoing operations. The non-financial causes can come from bad management or external shocks which reduces employees’ productivity and the company’s revenues. 

Examples of business failure exist across industries. Some famous business closures in the UK includes Friska, a series of successful restaurants that are shut down due to Covid-19 influences. Igloo Energy supplying energy for thousands of British homes also collapsed due to the rocketing wholesale price of gas and electricity. 

The main reasons why businesses usually fail are:

  • Poor cash flow management

  • Lack of capital funding

  • Bad management

  • Declining demand

  • Social and legal changes. 

There are 3 main types of business failures: preventable failures that can be predicted by management; unavoidable failures that take place due to macroeconomic factors; and intellectual failures that stem from business strategies. 

Final Reasons for Business Failure Quiz

Question

When does business failure happen?

Show answer

Answer

Business failure happens when a company ceases to operate or starts losing a lot of money. 

Show question

Question

What happens when a business fail? 

Show answer

Answer

When a business fails, it can no longer make a profit or generate enough revenue to cover its expenses.


Show question

Question

How are causes of business failures classified?

Show answer

Answer

Financial causes and non-financial causes

Show question

Question

What are the two financial causes of business failures?

Show answer

Answer

  • Poor cash flow management
  • Insufficient working capital

Show question

Question

What are non-financial causes of business failures?

Show answer

Answer

  • Poor management
  • External shocks: natural disasters, pandemic, technology, legal or political change, etc. 

Show question

Question

What are the three types of business failures?


Show answer

Answer

  • Preventable failures 
  • Unavoidable failures 
  • Intellectual failures 

Show question

Question

How can poor management result in business failure? 


Show answer

Answer

Poor management can result in low morale, decreased productivity of the employees, and the misuse of business capital which cause the company to lose money and meet failure. 

Show question

Question

 What is cash flow in simple terms?


Show answer

Answer

A net balance of cash moving in and out of the business. 

Show question

Question

When does negative cash flow happen?

Show answer

Answer

When cash outflow is greater than cash inflow

Show question

Question

What is an example of a predictable business failure? 


Show answer

Answer

Business initiating a product launch without doing careful market research

Show question

Question

What are some examples of unavoidable failures?


Show answer

Answer

Business failures due to political and legal change, natural disasters, diseases, plague outbreaks, etc. 

Show question

Question

What kind of company often faces intellectual failures?


Show answer

Answer

Companies in innovative space such as technology and medicine. 

Show question

Question

What is not an unavoidable business failure? 

Show answer

Answer

Natural disaster

Show question

Question

What is working capital?

Show answer

Answer

Working capital is the capital used in the day-to-day operations of a business. 

Show question

Question

What is an account receivable? 

Show answer

Answer

Money that is not yet paid by the customer for a good or service. 

Show question

Question

Where can businesses raise capital for their financial needs? 

Show answer

Answer

owners' own savings, family and friends, angel investors, venture capitalists, crowdfunding, or financial institutions. 

Show question

Question

When is there insufficient working capital?

Show answer

Answer

When current assets are less than the current liabilities. 


Show question

60%

of the users don't pass the Reasons for Business Failure quiz! Will you pass the quiz?

Start Quiz

Discover the right content for your subjects

No need to cheat if you have everything you need to succeed! Packed into one app!

Study Plan

Be perfectly prepared on time with an individual plan.

Quizzes

Test your knowledge with gamified quizzes.

Flashcards

Create and find flashcards in record time.

Notes

Create beautiful notes faster than ever before.

Study Sets

Have all your study materials in one place.

Documents

Upload unlimited documents and save them online.

Study Analytics

Identify your study strength and weaknesses.

Weekly Goals

Set individual study goals and earn points reaching them.

Smart Reminders

Stop procrastinating with our study reminders.

Rewards

Earn points, unlock badges and level up while studying.

Magic Marker

Create flashcards in notes completely automatically.

Smart Formatting

Create the most beautiful study materials using our templates.

Sign up to highlight and take notes. It’s 100% free.