The success or failure of a business depends on the good interaction and understanding of all the levels involved in the company
The failure of a business is an unfortunate circumstance before which a company can find itself. While most companies that fail do so within the first year or two of their life, others grow, reach maturity, and eventually fail.
The failure of a business can be viewed in various ways and can be the result of one or more causes. This article presents the types and major causes of business failure.
Types of business failures
Businesses can fail in several ways; if their returns are too low, if they go into technical insolvency or if they go bankrupt.
Low returns
A company can fail in the sense that its returns are low or negative. A company that constantly reports operating losses is because it fails to make a profit that allows it to cover all its costs. From the perspective of prospective and existing shareholders, this kind of operation is undesirable and likely results in the impairment of the company's market value.
If the business has negative earnings before taxes, technically the return of the owners is less than zero. If the business cannot achieve a return on its assets that is greater than its cost of capital, it can be considered to have failed.
Actually
The law is what considers when a business fails or not
Therefore, a company that each period simply turns out without profit or loss can be considered a failure by the owners for whose benefit it is in operation. In the marketplace, the consequences of failure due to low returns can be incalculable, although outsiders cannot pressure the liquidation of the company. When returns are low, owners and directors must initiate and complete corrective action.
Low returns, unless remedied, may eventually result in a more serious type of failure.
Technical insolvency
Technical insolvency occurs when a company cannot pay its obligations as they become due. When a company is technically insolvent, its assets are even greater than its obligations, but it is facing a liquidity crisis.
If part of its assets can be converted into cash within a reasonable period, the company may be in a position to avoid total failure. Although it cannot pay its bills, the company's assets have not deteriorated and its obligations have not increased to a point where it exceeds the fair value of the assets. However, a technically insolvent company is illiquid and cannot continue to run the business without certain changes.
Bankruptcy
Bankruptcy occurs when the obligations of a company exceed the fair value of its assets. A bankrupt company has negative equity. This means that creditor claims cannot be satisfied unless the assets of the business can be liquidated for more than their book value. Although bankruptcy is an obvious form of failure, the courts treat technical insolvency and bankruptcy in the same way.
Both are considered to indicate the financial failure of the business. Although low returns to business owners may not be consistent with the financial manager's goal of maximizing the owner's wealth in the long run, they are not considered legal evidence of business failure.
Single-product companies that fail to diversify are the most likely candidates for ultimate financial failure.
The law defines business failure as technical insolvency or bankruptcy. Although low returns are undesirable, as long as the company pays its obligations as they become due and does not allow its debts to exceed the fair value of its assets, it is legally considered satisfactory. Laws related to business failures tend primarily to protect creditors. If the claims of creditors against a company are in jeopardy, the law allows the company some recourse…
Main causes of business failures
The main causes of business failures are lack of managerial skill, economic activity, and corporate maturity.
Lack of administrative skill
The main cause of business failures is mismanagement. Poor management is responsible for more than 50% of all business failures. Numerous specific mismanagements can lead to business failure. Over-expansion, inadequate financial advice, a poor team of salespeople, and high production costs are the class of factors that can cause the ultimate failure of the business.
As a company is generally organized in a hierarchical fashion, the general manager, the president and the board of directors must jointly share responsibility for the failure of a company as a result of mismanagement. It is the responsibility of the board of directors to oversee the activities of the president, and general managers usually report to the president of the company. Consequently, each of these parts contributes to the total success or failure of the business.
Economic activity
Economic activity especially economic depressions can contribute to the failure of a business. If the economy goes into recession, the company's sales may decline sharply, leaving it with high fixed costs and insufficient returns to cover these fixed financial and operating expenses. If the recession continues, the probability of survival decreases.
Not all companies are equally affected by macroeconomic activity. In fact, each industry can be viewed as operating within its own microeconomy. Although the national economy may be prosperous, the industry within which the business operates may be in decline, and businesses in that industry may fail. On the other hand, the failure of a business during an economic boom is likely attributable to poor management.
Corporate maturity
Companies, like individuals, do not have infinite life. A business goes through the stages of birth, growth, maturity, and decline. The management of the company should try to prolong the growth stage through acquisitions, research and the development of new products. Once the business has reached maturity and started to decline, you should seek to be acquired by another business or liquidated before failing. Proper administrative planning should help the company delay final decline and failure.
