1.8.2 - Why businesses fail

Cash shortages and lack of finance

A business needs money available when payments fall due, not simply a favourable annual sales or profit figure.

Customers may pay after the business has paid for materials, wages and rent. A profitable order can therefore create a temporary cash shortage. In an illustrative business scenario, a furniture maker must pay employees this month, but an agreed customer payment arrives next month. Recorded profit on the order does not put money in its bank account now. If it cannot pay workers or suppliers, production may stop and further sales may be lost.

Poor control can worsen cash problems. Holding stock that sells slowly ties up money already paid to suppliers. Spending heavily on expansion before sales grow can leave too little for routine bills. Owners may underestimate start-up costs or take too much cash out of the firm. Unexpected sales falls and late customer payments can affect even a well-planned business.

Lack of finance means a business cannot obtain sufficient funds for its needs. An owner may have insufficient savings; a lender may reject borrowing because repayment looks uncertain; investors may doubt the expected return. Without temporary finance a short-term timing problem can become closure. Without suitable longer-term finance the firm may be unable to replace essential equipment or develop a viable product.

Borrowing is not always the answer: it creates repayment and interest commitments. More borrowing to support continuing losses may postpone rather than solve failure. A response should address the cause, for example more realistic expansion plans, earlier customer payments or less money tied up in slow-selling stock. A short cash shortage is a warning, not proof that closure is unavoidable if a feasible remedy exists.

Losing customers to competitors

A business is not competitive when its offer is insufficiently attractive compared with alternatives available to its customers.

Price, quality, service, convenience and reputation can all matter. A café charging more than rivals may still compete successfully if customers value its food and service. A low-priced café can still lose customers if it is unreliable. Competitiveness means matching what the target customer values, rather than always charging the lowest price.