Business failure

Question 1

Define business failure.

Answer 1

Business failure is when a business ceases to trade

It can also be when a business ceases to trade in a certain way, for example the BHS closure of shops, but the business continued online.

Question 2

Why are some shops closing?

Answer 2

The Office for National Statistics says British online sales increased to 17.3% of all retailing in the year to April, from 16.1% the previous year.

Businesses providing services and goods that would be hard or impossible to supply over the internet - beauty treatments, tattooing, cups of coffee, and so on - have taken over hundreds of premises.

Retailers face increases in the National Living Wage and rising costs in sourcing goods, with the decline in value of the pound.

Consumers are looking for low costs and convenience leading them to shop online, leading to a trend in high street shops closing

Question 3

List the different internal causes of business failure.

Answer 3

Poor efficiency
Poor marketing
Failure to innovate
Bad management of working capital
Lack of planning/business
Lack of funds
Narrow customer base

Question 4

Explain poor efficiency as an internal cause of business failure.

Answer 4

For example, Modelzone closed with 9 million pounds of unpaid debt due to an aggressive and disastrous expansion plan.

Unrealistic sales forecasts led to over exapansion.

Question 5

Explain poor marketing as an internal cause of business failure.

Answer 5

Businesses that launch new products that fail to meet customer needs are likely to stumble.

The use of inappropriate pricing strategies could mean that prices are too high or too low.

A business may invest too heavily in extravagant or inappropriate promotional campaigns.

Correct positioning in the market is also vital.

e.g. Sunny Delight marketed their juice as a healthy drink for kids, but it was actually pure sugar.

Question 6

Explain failure to innovate as an internal cause of business failure.

Answer 6

Businesses need to keep up with the dynamic market.

eg. Blockbuster was a bricks and mortar video rental

Kodak knew digital cameras were coming, however did not move fast enough into the digital world

Question 7

Explain bad management of working capital as an internal cause of business failure.

Answer 7

Management of working capital is critical if a business is to survive

Working capital performance is a measure of efficiency that compares a businesses’ assets to its liabilities

Inability to manage cash flow is the most common reason businesses fail. Many profitable and seemingly successful businesses have gone ‘belly-up’ because they haven’t had enough cash to pay their bills on demand, often due to focussing too much on profit and neglecting the importance of cash.

Question 8

Explain lack of planning/business as an internal cause of business failure.

Answer 8

At the start-up stage entrepreneurs can be prone to overlook the importance of planning. A thorough business plan is needed to provide a clear vision for the future so that owners can take an objective and critical look at the whole business idea, identify potential problems in advance so that the business is better prepared to deal with them.

Financial planning is crucial. Entrepreneurs need to ensure that the business is sufficiently funded to cope with weak cash flow in the initial stages.

Part of the planning process should involve seeking advice from relevant business people, potential investors and specialists. A range of courses are also available to help entrepreneurs in the setting up of a business.

Some small businesses fail because their owners may not be fully competent in the required skills.

Running a business is challenging and requires a multitude of skills. Entrepreneurs have to be creative, numerate, motivational and good decision-makers. They also need skills in communication, IT, marketing, negotiating, financial management and more.

Senior managers and business leaders may bring down companies almost single handedly with poor leadership (poor decision-making, not making urgent changes.) Failing to implement crucial strategies needed to protect their business from changes in the marketplace causes many companies to collapse.

Question 9

Explain lack of funds as an internal cause of business failure.

Answer 9

Some businesses fail because they cannot attract funding.

Established businesses may fail to attract funding because their track record is not good, so they’re high risk for investors/lenders.

New businesses often struggle to attract funding because they do not have a trading history, so are too risky

Some business owners think they can survive with limited amounts of capital by being cautious. However, if a business is undercapitalised it is likely to fail.

Question 10

Explain narrow customer base as an internal cause of business failure.

Answer 10

Some businesses rely too heavily on a small number of high-spending customers. Obviously, if they lose these large customers, sales will fall dramatically and survival becomes difficult.

Many farmers have gone out of business because they relied too heavily on contracts with large supermarkets. When terms for new contracts could not be agreed, farmers were left with an inadequate customer base.

Question 11

List the reasons a business might run short of cash (working capital).

Answer 11

Overtrading
Investing too much in fixed assets
Allowing too much credit
Over-borrowing
Seasonal factors
Unforeseen expenditure

Question 12

Explain overtrading and poor management of working capital.

Answer 12

Young and rapidly growing businesses are particularly prone to overtrading. This occurs when a business is attempting to fund a large volume of production with inadequate cash. Established companies trying to expand can also face this problem.

Question 13

Explain allowing too much credit and poor management of working capital.

Answer 13

A great deal of business is done on credit. One of the dangers is that businesses allow their customers too long for payment. This means that they are waiting for money and may actually be forced to borrow during this period. Failure to control debtors may also lead to bad debts.

Question 14

Explain investing too much in fixed assets and poor management of working capital.

Answer 14

In the initial stages of a business, funds are limited. Spending large amounts at the outset on equipment, vehicles and other capital items drains resources. It may be better to lease some of these fixed assets, leaving sufficient cash funds.

Question 15

Explain over-borrowing and poor management of working capital.

Answer 15

Businesses may borrow to finance growth. As more loans are taken out interest costs rise. This threatens a firm’s cash position and the overall control of the business. It is important to fund growth in a balanced way, perhaps by raising some capital.

Question 16

Explain seasonal factors and poor management of working capital.

Answer 16

Sometimes trade fluctuates for seasonal reasons e.g. agriculture (cereal farmers have a large cash inflow when their harvest is sold, but for much of the year they have to pay expenses without any cash flowing in.) This situation requires careful management, although it is possible to predict these fluctuations.

Question 17

Explain unforeseen expenditure and poor management of working capital.

Answer 17

Businesses need to be prepared for any unforeseen expenditure. Equipment breakdowns, tax demands, worker strikes and bad debts are common examples of this type of emergency expense. In the early stages of business development, owners are often hit by unforeseen expenditure. This can be because they lack experience or have not undertaken sufficient planning.

Question 18

List the external causes of business failure.

Answer 18

Economic recession
Strong pound (interest/exchange rates)
Competition
Changes in legislation
Changes in consumer tastes

Question 19

Explain the economic recession as an external cause of business failure.

Answer 19

As a country enters economic recession, customers start to save rather than buy.

They put off decisions to purchase large expensive items and they also switch to buying more inferior goods.

These buying decisions means that some businesses fail in a recession – whereas others might prosper (Poundland)

The level of business failures rose after the financial crisis in 2008. Many countries went into recession and thousands of businesses in the UK collapsed as a result.

A government’s economic policies can also contribute to business failure:

In the last ten years there have been cuts in the public sector, which have resulted in job losses, wages in the public sector have been frozen and some taxes have increased.

This has led to a drop in disposable income for many people in the UK, which results in lower demand, particularly for non-essential products and services. Businesses that produce these are likely to feel the effects of an economic downturn more severely.

Question 20

Explain the strong pound as an external cause of business failure.

Answer 20

Strong pound means that manufacturing businesses who heavily export will be affected
It means their goods and products that they manufacture will cost their customers more
Some businesses shift production overseas to counter this effect but not all can afford to do this

Interest rates dropped after 2008, making borrowing cheaper. However, a sharp increase in interest rates could cause difficulties for some businesses. Those with large debts would be at risk, as would businesses that depend on consumers using credit to fund their purchasing.

Businesses that import and export are also affected by changes in the exchange rate. For example, a business that relies heavily on the export market will suffer if the exchange rate rises sharply. Higher exchange rates mean that overseas customers have to pay more for UK goods and services. This can reduce demand and force marginal firms into administration.

Question 21

Explain the competition as an external cause of business failure.

Answer 21

The strength and success of business rivals can push others out of business.

Competitors might bring out superior products or read market conditions more effectively.

They may charge lower prices because their costs are lower.

They may be a larger, more powerful company and use destroyer pricing to drive smaller rivals out of the market.

In recent years many manufacturers in Western nations have been outcompeted by low-cost producers from China and other emerging nations.

Question 22

Explain the changes in legislation as an external cause of business failure.

Answer 22

Changes in government legislation can lead to business failure.

Failing pubs/bars blamed the legislation that banned smoking from inside public places for their demise.

In 2014 a number of lenders withdrew from the market after the government passed legislation to control the supply of so-called ‘payday loans’.

In April 2014 the West Cornwall Pasty Company went into administration citing the government’s so-called ‘pasty tax’ (tax on items sold hot) as one reason. (However, the company was taken over shortly afterwards and survived.)

Question 23

Explain the changes in consumer tastes as an external cause of business failure.

Answer 23

Consumer tastes are not constant. They are likely to change over time and businesses that cannot adapt to such changes are more likely to fail.

The changing patterns and trends in consumer behaviour in the fashion industry are particularly volatile.

Question 24

Explain the changes in market prices as an external cause of business failure.

Answer 24

Some businesses have very little control over the prices they charge. In certain industries firms are ‘price takers’.

Oil producers have to sell their output at the global market price. Consequently, when these prices fall, marginal producers will leave the market. If the price were to fall below the break-even price for a long period of time many producers won’t survive.

Farmers in the UK are also ‘price takers’. In 2014 the livelihoods of many dairy farmers were threatened because the price of milk dropped in the market to about 27p per litre. It was reported that this was below the break-even price of around 30p per litre for many farmers.

Question 25

Explain financial causes of business failure.

Answer 25

Many businesses fail for financial reasons. They either become bankrupt (where they are taken to court by creditors) or they become insolvent (where they cease trading of their own accord). The most common reason for this failure is the shortage of cash – the inability to pay immediate debts. The importance of effective cash-flow management in business cannot be overemphasised.

Question 26

Explain non-financial causes of business failure.

Answer 26

In some cases business failure results from factors such as a lack of planning, a lack of business skills, inability to compete effectively, failure to meet customer needs, reluctance to change and adverse economic conditions. These may be classified as non-financial factors as they are not linked directly to money issues. However, even these factors are likely to result in financial failure if they are not addressed by a business.