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What are the Main Causes of Business Bankruptcy?

We’ve all heard that old saying; ‘Half of all Australian businesses fail within the first three years”, followed by additional spirit-crushing lines such as ‘Most don’t see any profits for the first year’ etc.

Small businesses file for bankruptcy more often than you think Australia-wide for a spectrum of reasons driven by a range of generally compounding problems.

But is there a single root cause of businesses closing their doors? Or is it the combination of issues gradually drifting operators into forced liquidation?

Let’s take a look.

Why Businesses Actually Fail

SMEs really only cease operations and shut shop involuntarily due to three complications; lack of income, loss of capital, or no credit.

Reaching this stage, however, has to stem from some point, commonly resulting from a series of financial or other business-related decisions that negatively impact them.

In addition to the wrong turns taken along the financially-destructive path to bankruptcy, many factors influence why and when a business might become insolvent, including:

Lack of industry-specific knowledge and experience

Introducing a business into an industry you don't know much about as a first-time owner can be detrimental from the get-go. Getting started usually requires at least some prior experience either working within a similar environment or operating other people’s businesses at a management level.

While many find it exciting and enjoyable to turn their hobbies into income, the numbers have to make sense first.

Dwindling sales over a long time place you on the fast track to liquidation, with a lack of expertise and forecasting primarily to blame.

Inadequate finances

Planning your grand opening while running on the bare minimum is one of the most negatively experimental choices you can make. It’s a ‘Day 1’ mistake commonly made out of excitement and an eagerness to start generating customers and finally, an income, and unfortunately is often the beginning of other bad business-related habits.

Delaying your first sales and your entire venture is the best idea if you’ve found you’ve overestimated initial start-up costs or even lacked positive cash flow early on.

Poor financial management and overspending

In most cases, new business owners make many purchases that aren’t actually necessary in the beginning processes related to getting started. Ensuring you keep that balance between operating on fumes and overspending on debt-creators is crucial for business survival.

As likely the number one reason for small business bankruptcy in Australia, poor financial management is both the start and end of most failing operations.

Clients refusing to pay

Many businesses fall into traps relating to giving customers and clients too much leniency when it comes to paying invoices. While seemingly being something that’s in your best interest during those client-base building periods, allowing clients to delay paying you can have serious consequences.

Worse yet, clients who refuse to pay significant outstanding invoices can leave businesses in the lurch, falling behind with mortgage or rental payments, accumulating debts for preordered inventory, generating backlogs of unpaid wages etc.

This creates a snowball effect over extended periods, forcing many Australian businesses into premature insolvency.

Incapable of competing

Underestimating your competition, their capabilities and their position within certain markets can also be baby steps towards business failure without you even realising it. Oftentimes longstanding competitors are financially capable of offering products and services more attractively than what’s required for you to remain profitable. It’s not uncommon for ‘big business’ to swoop in on the smaller, less experienced players which eventually drives them out of their profitability range.

Problematic business ventures

High-risk ventures can pay off in the long run, however many people utilise small successes within their businesses in expansion attempts. This can sometimes overcomplicate what was once a simple but profitable product, service or other concept and plunge people into hefty, unrecoverable debts.

Credit complications

Borrowing large sums of money on the notion that you’ll use future profits to repay the debts sees significant percentages of businesses claim bankruptcy every year. While borrowing too much, in the beginning, is usually the culprit, business owners also continue taking on unaffordable loans to pay off other debts or help with getting back on track.

This strategy can prove to be incredibly financially dangerous and often requires the business to liquidate in an attempt to recover.

Avoiding Bankruptcy

Easier said than actioned, we don’t start a business hoping we’ll just keep afloat. But sometimes things start to go backwards and we struggle to achieve a healthy and profitable financial position for oftentimes long periods. While claiming bankruptcy is a relatively extreme scenario, small business total financial failure is something that generally applies itself intermittently until it’s too late to begin a plan to reverse the damage.

Avoiding potential liquidations and total business failure comes down to education, experience and learning from mistakes, particularly regarding:

  • Financial management - Improving cash flow, recognising bad spending habits and having adequate savings for unexpected or other emergency situations.

  • Having surplus capital to get started - Knowing the consequences of borrowing money under the presumption it’ll be paid back with profits you’re yet to earn.

  • Research and development stages - Finding out what works within the market prior to launching products and service structures at a high risk of failure.

  • Implementing secure payment/billing conditions - Ensuring you’re being paid on time to avoid falling behind with your business's expense payments which incur debts.

Contact Ironbark Industries Bookkeeping today to discuss our bookkeeping services, your specific requirements, or any other financial management enquiries.

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