Business Failure

• what are the internal reasons why businesses fail?

  • poor planning
  • lack of leadership
  • ineffective marketing
  • cash flow problems
  • lack of funds
• how does poor planning lead to business failure?

  • ineffective business plan
  • poor budgeting
  • lack of research/development
  • little innovation
• how does lack of leadership lead to business failure?


  • poor decision making
  • lack of urgency/experience
  • failure to delegate
  • lack of skills to run a business
• how does ineffective marketing lead to business failure?


  • not enough market research
  • poor understanding of customer needs
  • flawed products and pricing decisions
  • promotional mistakes
• how does cash flow problems lead to business failure?


  • not enough market research
  • poor understanding of customer needs
  • promotional mistakes
  • flawed products and pricing decisions
• how does lack of funds lead to business failure?


  • failure to attract investment
  • difficulties in borrowing
  • limited owner capital
• what are the external reasons why businesses fail?

  • economic challenges
  • changes in consumer tastes
  • legal factors
  • market challenged
  • technological change
  • change in legislation
  • competition
• how does economic challenges lead to business failure?


  • periods of recession
  • increasing interest rates increases business costs
  • exchange rate fluctuations affect planning can increase costs
• how does changes in consumer tastes lead to business failure?


  • needs for frequent market research increases cost
  • dates stock may be unsellable
• how does legal factors lead to business failure?


  • legal rulings can affect business operations
  • legislation - increases staffing/transport costs
  • products/assets may need to change to meet legal standards
• how does market challenged lead to business failure?


  • competitors undercut prices to gain market share
  • market selling prices may be too low to achieve break even
• how does technological change lead to business failure?


  • product innovation leads to disappearance of a business market
  • significant capital spending is needed to replace obsolete non-current assets
• liquidity?


  ability of business to meet its short term commitments with its available assets
• how is managing liquidity a key way to manage risk in business?


  helps business to prepare for the unexpected
• equation for current ratio?


  current assets / current liabilities
• current ratio?


  • effective liquidity measure for businesses that hold little stock
  • result indicates how many of current assets it has available to cover each £1 of short-term debt
• acid test ratio/liquid capital ratio? 


  • important measure of liquidity for businesses that hold a large amount of stock
  • least liquid form of current assets is deducted so acid test ratio provides a more realistic measure of the businesses ability to meet short-term debts quickly
• equation to work out acid test ratio?


  acid test ratio = current assets - inventory / current liabilities
• ways to improve liquidity:


  • manage business better
  • use cash flow forecasts to identify potential cash flow issues before they arise
  • budget effectively + consider zero budgeting to control spending
  • set clear financial objectives
• how does reducing credit period offered to customer improve liquidity?


  • collected money owed from customers increases level of current assets
  • customers may move to competing business that offer better credit terms
• how does asking suppliers for an extended repayment periods improve liquidity?


  • current liabilities will not be reduced
  • paid suppliers for other purposes
  • suppliers may be unwilling to extend credit terms
• how does making use of overdrafts facilities or short-term loans improve liquidity?


  • current liabilities will increase
  • business spends more money than it has in bank account
  • banks may be reluctant to lend to businesses with cash-flow problems
• how does selling off excess stock improve liquidity?


  • less liquid current assets will be reduced + converted into more liquid forms of current assets
  • storage/security costs may be reduced
  • stock may need to be sold at a low price to attract sales
• how does selling assets and leasing fixed assets instead improve liquidity?


  • current assets/liabilities will increase
  • business must use assets but must make regular payments to the leasing company
• how does introducing new capital and reduce drawings from business?


  • current assets increases
  • new capital introduced by owner or additional investors
  • results in dilute of control of business
• working capital?


  money that a business has to fund its day to day activities
• equation for working capital?


  current assets - current liabilities
• lack of working capital leads to business failure - business cannot meet its immediate financial obligations
• liquid?


  an asset that is capable of being used to settle debts immediately
• effective management of working capital involves careful cash management:


  • debtors + inventory are less liquid
  • those struggling with lack of capital may look to convert current assets into cash as soon as possible
  • requesting an extension of payment terms from suppliers can increase working capital in short-term, cash stays in business
  • making use of short-term borrowing options (overdrafts) improves businesses working capital - can access more cash
• what happens in a business has too much working capital?


  • if holding too much cash: business will miss out on benefits of investing on assets/investments - opportunity cost: interest rates are high which is a reward
  • if holding a large amount of inventory, it may incur extra storage costs and use cash 'tied up'