7 Reasons Why Businesses Fail

According to 2022 Bureau of Labor Statistics data, about 20% of businesses fail in their first year. Around half make it to year five, and only 1 in 3 lasts 10 years. These numbers have remained relatively consistent since the 1990s and are similar across various industries.

The relatively high risk of failure is something most small to midsize businesses are aware of. While it might not be pleasant to think about, understanding why businesses fail is valuable for recognizing the warning signs and mitigating risks. Here are seven of the most common reasons businesses fail and what you can do to improve your chances of success.

Key reasons why businesses fail

Financial challenges

Insufficient capital is one of the primary reasons that businesses fail. Several factors can leave a business without the funds it needs to sustain operations and grow:

• The business monitors daily expenses such as inventory and payroll but is less diligent about tracking revenue and ensuring that short- and long-term financial obligations can be met.
• Ineffective pricing or inventory management strategies cause lost revenue.
• A poor market fit or marketing strategy means low or decreased sales.
• The business underestimates the capital required to sustain itself until it becomes profitable.
• The business struggles to qualify for funding, especially from traditional sources such as banks.

It’s worth noting that even highly profitable businesses can suffer from poor cash flow, leading to business failure. This is often the result of lengthy payment terms. For example, if your business makes a huge sale, you could still run out of the cash needed to operate and meet customer demand if you must wait 90 days or more to receive payment. 

Inadequate business strategies

Successful businesses not only have a clear vision but also investigate their industry and analyze variables that could diminish cash flow. Before delivering any products or services to customers, businesses should develop a comprehensive plan that includes, at a minimum:

• A summary of the business’s purpose, goals, offerings and value proposition.
• An industry analysis that includes potential opportunities, risks and competitor activities.
• Financial information, funding requirements and sources.
• Marketing and sales strategies.
• An overview of the business’s required functional roles and expertise.

This process is crucial for validating market fit and anticipating how the business will adapt to challenges, such as an economic downturn. A business without a sound plan risks entering an oversaturated market, being unprepared for market changes or finding itself at sea without a clear guiding objective. Even if a business starts with an exhaustive plan, these issues may still arise if the strategy isn’t revisited and adapted regularly.

Mismanagement

Small to midsize business owners tend to wear many hats. While they may understand the product or service inside out, they often manage business functions that are outside of their wheelhouse. Leadership that lacks skills in unfamiliar areas — such as finance or marketing — could be setting the business up for failure if they attempt to handle these roles in an effort to save costs.

Mismanagement can also stem from an insufficient business plan or decision-making that disregards company financials, competitors, market risks and other external factors. The business owner — who may be an industry expert — might not have the necessary skills to manage people and lead the business on a successful path.

Excessive growth

Rapid growth can seem appealing to small business owners, especially if they want to attract investors or see returns quickly. The reality is that successful businesses usually take time to become profitable and expand, and a growth trajectory that rises sharply is not sustainable. A business focused on rapid growth — perhaps more than on the actual value it provides customers — may be poised for failure if it:

• Is overwhelmed with demand and lacks the resources and infrastructure needed to fulfill customer requirements.
• Lacks the time and resources to measure successes and failures, and does not adapt its strategy accordingly.
• Sees lower customer satisfaction with a decline in product or service quality.
• Becomes disorganized and misaligned with its original values and mission.
• Must hire many new employees quickly and experiences high turnover.

Limited customer base

Long-term, stable accounts are big wins for small to midsize businesses — they offer reliable revenue and often come with large contracts that enable growth. However, relying on just a few of these customers increases risk, just as an investment portfolio that is not diversified is at risk when the market takes a downturn. If just one of these customers goes out of business, reduces demand or switches to a competitor, the impact on your bottom line could be enough to put you out of business.

Limiting your customer base also gives customers leverage. Understanding your reliance on their patronage, long-term customers may try to negotiate more favorable terms in exchange for their loyalty, which can diminish your cash flow. For example, a customer may extend payment terms in its favor so it can retain funds for longer and increase cash flow. However, waiting extended periods for invoices to clear accounts receivable can deplete your working capital and jeopardize your business, even if the sale is lucrative on paper.

Marketing oversight

More than 7 in 10 small to midsize businesses in the United States lack a content marketing strategy, signaling that marketing is often low on the priority list. However, neglecting this essential function often leads to business failure. Without reaching your customer base and resonating with their needs, you are unlikely to generate the revenue needed to operate and expand.

Marketing research and campaigns take a significant amount of resources and expertise, something many businesses fail to adequately budget for in their business plans. And if your business does budget a healthy amount of capital for its marketing efforts, how effective have these initiatives been? 

A marketing strategy can often contribute to business failure if it has unrealistic goals, lacks a measurable, data-driven approach or fails to help the business stand out from its competitors. Failing businesses may also limit their marketing reach rather than diversifying across channels, or attempt to market without sufficiently defining their audience, positioning and messaging.

Inflexibility

New technologies surface daily, digitally transforming businesses across every industry. Those that neglect to understand and integrate innovations into their product or service — where it makes sense — will be pushed out of the market by competitors that do. Businesses that are agile and willing to adopt new processes, products or services are more likely to become more efficient, differentiate their offerings and grow.

While technologies such as artificial intelligence, virtual reality and blockchain are advancing, many businesses are adapting simply by prioritizing the value of data and data-related technologies. These tools can improve the business’s knowledge of its target market and fuel innovative product development. They can also illuminate the business’s strengths and weaknesses and can inform process changes and business strategy. Many businesses are also embracing environmental, social and governance (ESG) initiatives, recognizing not only their impact on people and the planet but also on the business.

Boosting your business’s chances of success

With a clear understanding of why businesses fail, how do you ensure that your business doesn’t end up in any of these situations? As you might have guessed, your business can reduce the likelihood of failure by making smart investments. This might mean: 

• Investing time and resources in a comprehensive business plan, and continuously adapting it.
• Hiring or outsourcing the right talent to ensure that business functions are performed effectively and the business grows at a sustainable pace.
• Establishing a sufficient marketing budget and strategy so you can reach and convert your audience, as well as diversify your customer base.
• Implementing innovative tools that improve business processes and help you differentiate your offerings from your competitors’.

However, a business’s biggest risk is running out of capital — and to act on any of the above strategies, you must have enough financial resources. This is why cash flow management should be your first priority if you want to boost your chances of success. 

The first step in effective cash flow management is to forecast and review your financials regularly, which allows you to predict cash shortages, meet your financial obligations and plan for growth. This is crucial whether or not your business is profitable because cash trapped in accounts receivable — usually due to lengthy payment terms — can deplete working capital even if your sales are high. 

If you’re unsure where to start, consider your cash conversion cycle (CCC). This metric is a measure of how long it takes to convert investments into cash flow from sales, and it is a valuable indicator of potential issues. From there, you can assess various strategies for improving and maintaining a healthy cash flow — whether that’s proactively securing funding, prioritizing costs for business growth or leveraging an early payment program to accelerate your receivables.

Want more detailed information on how to manage your cash flow? Click here to learn more.