Why Businesses Fail – Newsletter Edition

Why Businesses Fail

Hi!

I recently had a business owner come to me looking for help.  His business was on the verge of being out of cash and he was exhausted from worrying.

It’s no secret.  Running a successful business is no easy feat, and unfortunately, many businesses fail despite the best efforts of their owners and employees.

As a business owner, it’s crucial to understand the common reasons behind business failures and learn how to navigate the challenges that come with entrepreneurship.

In this email, I will delve into the main factors that contribute to business failure and provide you with valuable tips to help you steer your company towards success.

The Fundamental Reason Why Businesses Fail

At its core, a business fails when it runs out of cash. This may seem obvious, but it’s a harsh reality that many entrepreneurs face. Profitability is undoubtedly important, but a profitable business can still fail if it doesn’t have enough cash to pay its bills when they’re due. On the other hand, an unprofitable business can survive for an extended period if it has access to sufficient cash reserves or funding.

Identifying the Need for a Turnaround

A turnaround is the process of saving a business that is on the brink of failure. It becomes necessary when a company is facing a real and present risk of running out of cash, with no clear solutions on the horizon. If left unchecked, this situation can lead to technical bankruptcy, where creditors take action to protect their interests. This can result in suppliers cutting off deliveries, employees not showing up for work due to missed payroll, and even the landlord padlocking the doors.

To avoid reaching this critical point, it’s essential to spot the warning signs early. Regular cash flow forecasting is key to identifying potential risks and allowing you to take corrective action while you still have options. Create base case, upside case, and worst-case scenario forecasts for both the short-term (13-week rolling) and long-term (12-18 month rolling) to ensure you have a comprehensive view of your business’s financial health.

Root Causes of Business Failure

While numerous factors can contribute to a business running out of cash, they often fall under three main categories:

1. Bad Business

A bad business is one that lacks fundamental competitive advantages. To thrive in the long run, a business needs access to something that allows it to operate more efficiently or effectively than its competitors. This could be a manufacturing process that enables production at a lower cost, a brand that commands pricing power, or a unique distribution network. Without these “moats,” a business is vulnerable to being outcompeted in the market.

It’s important to note that a bad business is not the same as a good business with a poor strategy. The latter is a management issue, while the former is inherent to the business itself. A bad business can survive for a long time with strong management and a healthy balance sheet, but it will eventually succumb to competitors who have the advantage of favorable industry trends.

2. Bad Management

Weak management is another common reason for business failure. This can manifest in two ways: poor strategy selection and poor execution. Management teams that excel in execution but fall short in strategy may win battles but ultimately lose the war by failing to capitalize on the business’s inherent strengths or adapt to changing market conditions.

On the other hand, management teams that develop sound strategies but struggle with execution can expose their shortcomings quickly. While their plans may look impressive on paper, they fail to translate into real-world results. Execution is a critical skill that can create a significant competitive advantage when done well, but it can also lead to a company’s downfall when lacking.

3. Bad Balance Sheet

Sometimes, a business’s fundamentals and management may be strong, but it is hampered by a problematic balance sheet.

This often means having too much debt, the wrong type of debt, or insufficient liquidity. A bad balance sheet can take many forms, such as:

– Inadequate liquidity levels that hinder growth and investment

– Interest rate exposure on debt

In the current economic environment, many businesses are grappling with the challenge of refinancing debt that was taken out during the era of ultra-low interest rates. As rates have risen significantly, these companies face the prospect of being unable to refinance their debt at sustainable levels.

While a bad balance sheet may be the result of past missteps, it can also be a legacy issue that current management must address.

Tips for Avoiding Business Failure

1. Regularly forecast your cash flow: Develop a habit of creating cash flow forecasts for various scenarios (base case, upside case, and worst-case) on both a short-term and long-term basis. This will help you identify potential cash crunches and take proactive measures to address them.

2. Identify and leverage your competitive advantages: Take an honest look at your business and pinpoint the unique strengths that set you apart from your competitors. Ensure that your management team is fully capitalizing on these advantages and continuously seeking ways to extend or develop new ones.

3. Foster a culture of execution: Emphasize the importance of execution throughout your organization. Set clear goals, establish accountability, and create a culture that values taking action and delivering results. Remember that a mediocre strategy well-executed is often better than a great strategy poorly executed.

4. Monitor your balance sheet: Keep a close eye on your balance sheet, particularly if you have significant debt or liquidity concerns. Be proactive in addressing any issues, such as refinancing debt well before maturity or securing additional liquidity sources.

5. Plan for contingencies: When forecasting, consider the possibility that multiple negative events could occur simultaneously. Don’t assume that risks are independent of each other; instead, plan for scenarios where multiple challenges compound to create a more significant impact on your business.

6. Seek professional advice: Don’t hesitate to seek the guidance of experienced professionals, such as accountants, lawyers, and financial advisors. They can provide valuable insights and help you navigate complex financial and legal issues.

The Bottom Line

Understanding the reasons behind business failure is the first step in avoiding them. By focusing on your competitive advantages, fostering strong management and execution, and maintaining a healthy balance sheet, you can significantly improve your chances of long-term success.

Remember, when things start to go wrong, they can escalate quickly. Stay vigilant, proactively address any warning signs, and don’t be afraid to seek help when needed.

I hope this email has provided you with valuable insights and practical tips to help your small business thrive.

Warm Regards,

Tyler

Disclaimer: This email is for informational purposes only and should not be considered as professional financial, legal, or tax advice. Always consult with qualified experts before making significant business decisions.

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