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Causes Of Business Insolvency

Dec 12, 2007
It is a known fact that only about 50% of small businesses continue to exist after about three years from being formed. There are many reasons for this occurrence but the foremost explanation is business failure. Business failure does not happen only to small start-ups but also to big businesses that have been set up for quite some time and have experienced a moderate measure of success.

It's true that insolvency happens to all business but smaller businesses stand a greater risk of failure. This is due to the fact that small businesses lack the financial back up that big businesses have. Additionally, most small businesses find it hard to source finance from banking institutions due to the lack or non-availability of security to be offered.

Many businesses fail because of the lack of financial control. Managers who know next to nothing about accounting procedures and practices fail to notice that cash flow problems are beginning to set in. A manager who does not possess accounting skill needs a competent bookkeeper to do the job. It is important to know the current cash flow of the business since it is one of the causes of business failure.

For new start ups, the business cash flow problem is something that needs prime attention. A cash flow problem arises when the money generated from sales is not enough to cover the production cost. Some companies however, do not generate income for a period of time. An example of this is a Christmas decor company. Almost 80% of the sales will be generated during the last two months of the year-November to December. As the company will need to pay the staff, to pay for taxes as well as production cost, sufficient operating capital is needed. This gives rise to another cause of business insolvency- lack of funds.

The lack of start-up capital is a problem most small businesses encounter. During the start of the business, owners will be forced to take any source of finance; even one with very high interest rates. High interest rates make liabilities higher than the assets. Loans with high interest rates and unrealistic repayment schedules are grabbed by the business owner without realizing that this can cause his business to fail.

Credit card is one of the most common sources of finance. Although entrepreneurs think that credit cards as heaven sent, they should be aware that credit card interest rate can be as high as 20% annually. This will eat up most of the revenues without making a significant dent on the principal amount borrowed.

Business insolvency is not caused by problems in your business alone. It may be caused by a domino effect from factors outside the business such as customers, suppliers and other competing business and even by government restrictions. Business failure starts when trading is no longer possible without meeting new problems; when debts are not paid as they become due and when financing operation cost is no longer feasible.

It is important to face the fact that the business is encountering financial troubles so that early on the entrepreneur will have a choice whether to continue running the business or to enlist the help of business management professionals.
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