Category: Comment and Opinion

Why do MOST small businesses fail?

What is a small business?

A good definition would be … less than 20 employees for non-manufacturing industries, and less than 100 employees for manufacturing industries.

Key features of small business

Independent from outside control
Smallness compared with other firms in their industry which inevitably means that many have major resource problems at two critical points – in the first few months (and even the first year or so) after start-up, and as they start to grow at more than a casual rate.
Owner managed whereas larger organisations are managed by professional executives who are salaried employees.

Typical small business profile

People

A close and loyal work team
Low employee turnover
Education, experience and skills: practical but narrow
Lack of specialist employees
Lack of promotable staff
Age and health of owner(s)

Management

Owner managed
Strong desire for independence
Centralised power and control
Leadership: personal but task oriented
Owner idiosyncrasies
Intrusion of family interests
Reluctance to take risks
Informal and inadequate planning and control
Decision making: more intuitive than rational
Responses: reactive rather than innovative
Major resource problems during first few month
Major resource problems during growth

Operations

Labour intensive work
Limited process and product technology
Multifunctional work and management roles

Market

Narrow product/service range
Product dedicating rather than customer orientation
Limited market share and heavy reliance on few customers
Lack of control over environment

Finance

Limited ability to obtain funds

Small businesses fail in early years

Alan Williams study of 41 000 new firms between 1973 and 1994 (22 years) 26 564 (64.5%) sample firms failed. Of the firms that failed just over 10 percent qualified as long term survivors.

The first two years are the most dangerous with nearly half failing. In the first two years poor management takes its toll. Many new owner/managers have made the wrong decision. However as small firms survive each year generally their ability to survive the following year improves.

The number of early failures is increasing

There is no reason given for this increase. It may be due to factors such as changing economic situation and the fact that more people are being made redundant and are going into business without the appropriate management skills. Interestingly total failure rate of about 70 percent has remained fairly steady over the 20 year period.

Non-financial reasons for failure

According to Alan Williams’s studies nearly 15 percent (approximately 6,000) close down for “non-financial” reasons.

How many businesses fail?

Estimated about 40,000 small firms fall in Australia each year.

Our failure rate is close to 4 percent of the small and medium sized business population with estimated average loss of over $115,000. Loss to economy of about $45 billion per year.

Financial problems of some kind are the direct cause of the great majority of most business closures, and also contribute to personal problems that interact with other problems areas (such as family/marital discord and poor health) and hence lead indirectly to decisions to close down.

Reported reasons for business failures

Study revealed:

Lack of business/management experience skill and ability 62.3%
Inadequate records 56.2%
Inadequate sales 47.7%
Inflation and inability to operate with fluctuating costs and prices 39.3%
Union interference and problems 28.7%
Excessive private drawings 24.4%
Under capitalisation (especially at start up) 23.4%
Overuse of credit (slow collections and bad debts) 21.6%
Inventory problems (slow stock turnover, dead stock, poor records) 20.8%
Inability to use/understand financial reports and statements 18.0%
Rapid rate of technology change (affecting product knowledge, skill requirements,
staff training, work quality, customer expectation, etc) 17.7%
Failure to seek and use external advice 17.6%
Lack of financial planning (no budgets, inadequate cash reserves, tax payment problems, etc) 17.5%
Industry-wide downturns 14.9%
Problems with staff supervision, motivation and productivity 13.5%
Inability to get and keep good staff 11.9%

Major reasons for failure

Major reasons for failure of small enterprises in Australia, in order:

Poor financial management and liquidity (cash flow) problems
Overall management inexperience and incompetence
Sales and marketing problems
Problems coping with inflation, recession, and other economic conditions external to the firm
Poor or non-existent books and records
Staffing difficulties
Difficulties with unions
Failure a to seek and use expert advice

Conclusions

Management capability

An inability to manage a business is by far the most significant underlying reason for at least 95 percent of all small business failures.