Chapter 15 · Reasons for Business Failure
Why can a growing or seemingly successful business run out of cash, lose customers or close altogether?
Learning objectives
- Explain why businesses fail because of cash-flow problems and lack of finance.
- Assess how poor competitiveness, cost control and leadership threaten survival.
- Understand why businesses need to innovate and adapt to market changes.
Business Failure
Business failure occurs when a business can no longer continue trading successfully and closes or becomes unable to meet its obligations. Both newly established and long-running firms can fail when they cannot generate enough cash or remain competitive.
Failure may result from one serious problem or several connected problems: a business can be profitable on paper but run out of cash, struggle to raise funds, lose customers to competitors, or fail to respond to market change. Sound financial planning is therefore critical from the beginning.
PepperTap began in 2013 as an app-based grocery-delivery service. By 2015 it operated in 17 cities and received around 20,000 daily orders. It closed in 2016. Smaller shops often lacked accurate electronic inventory information; discounts of about 20% and the cost of fast delivery and staffing were high. Even as orders grew to roughly 30,000 a day, cash losses made its operations unsustainable.
Key lesson: rapid sales growth does not guarantee survival. PepperTap needed reliable stock data, affordable service costs, and enough cash to maintain deliveries.
Cash Flow Problems
A business needs cash to pay workers, suppliers, rent, loans and other bills when they fall due. Profit and cash are not the same: credit sales may count towards revenue before customers actually pay. A business may therefore be profitable yet fail because it cannot pay its debts on time.
Overtrading
Overtrading happens when a business expands sales or production too quickly without sufficient working cash. It must buy stock, recruit workers and pay suppliers before receiving enough money from customers. Even a successful, growing business can run out of cash.
Valtrex Construction, a wooden-house specialist, expanded rapidly. Its reported sales in 2014 were around US$45 million, but the business could not finance its growth. It failed in 2016 owing approximately US$12 million to suppliers, resulting in 85 redundancies. Overtrading was an important cause.
Investing Too Much in Fixed Assets
Buying expensive vehicles, property, machinery and equipment at start-up may use most of the available cash. Assets may be useful, but the business still needs money for everyday running costs. Leasing equipment can sometimes preserve cash reserves instead of buying it outright.
Allowing Too Much Credit
When customers buy on credit, the business delivers goods now but is paid later. Allowing very long payment periods can create a shortage of cash, especially when suppliers expect quicker payment. The business may need a short-term loan or overdraft while waiting for customers to pay.
Over-Borrowing
Businesses sometimes borrow to grow, but taking on too many loans raises repayments and interest charges. Higher financing costs leave less cash for operations. Owners may seek extra equity capital rather than take on more borrowing where appropriate.
Seasonal Factors
Cash receipts can vary across the year. For example, harvest sales may bring a large cash inflow, but farms still face costs during the months without harvest income. Forecasting helps prepare for these predictable gaps.
Unexpected Expenditure
A breakdown, bad debt, unexpected tax payment or strike may cause unplanned costs. Firms with limited reserves are especially vulnerable. Careful financial planning and cash buffers reduce the risk.
External Factors
Changes outside a firm’s control—such as legislation, consumer tastes, a wider economic downturn, or input-price changes—may disrupt its cash flow. For example, declining oil prices in 2014–15 created challenges for oil-and-gas businesses.
Poor Financial Management
Owners may fail to forecast accurately, spend cash before customers pay, or misunderstand how credit transactions affect available funds. A cash-flow forecast, monitoring receivables and prioritising essential expenditure help managers avoid liquidity problems.
Putting the causes together: a growing firm that grants long credit periods, buys too many fixed assets and borrows heavily can become cash-starved even when customer demand appears strong.
Lack of Finance
A new business may struggle to attract finance because it has no trading record. Lenders or investors may see it as risky. An established business with poor past results may also be unable to persuade finance providers to lend or invest.
Owners sometimes underestimate how much funding is needed to survive early losses, purchase inventory, pay staff or deal with unexpected events. Consider restaurants, where set-up costs can be high and firms may use cash for months before attracting a steady customer base.
- At start-up: calculate likely set-up costs, working capital and contingency needs realistically.
- During operations: keep accurate records so lenders can assess performance and the business can react early.
- Before expansion: check whether cash reserves, loans or owner capital are sufficient to support new activity.
Difference from cash-flow problems: lack of finance concerns access to funding overall; cash-flow problems concern the timing and availability of money to meet immediate payments. The two problems are often closely related.
Check your understanding · Halfway
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What does business failure mean, and why can a profitable firm still fail?
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A business fails when it cannot continue trading. It can record a profit but have insufficient cash to pay bills, for example when customers delay payments while suppliers need immediate payment.
Explain overtrading using the Valtrex Construction case.
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Overtrading means expanding too quickly without enough working cash. Valtrex accepted growing business but could not finance the resources needed, and it subsequently owed suppliers large amounts.
Give two reasons why a newly established restaurant might lack finance.
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Start-up costs can be underestimated, and a new restaurant may lack the trading record or security needed to persuade lenders to provide funds.
Why might leasing equipment help a business avoid cash-flow problems?
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Leasing can avoid a large up-front purchase of a fixed asset, leaving more cash available for wages, inventory and other routine payments, although rentals remain payable.
A firm sells most of its products on three-month credit. Explain one cash-flow risk.
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The firm must pay costs before receiving money from its customers; if too much credit is allowed, it may need extra borrowing or fail to pay bills when due.
Explain two lessons managers can learn from the PepperTap case.
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Reliable supplier and inventory information is necessary for customer service; generous discounts and expensive fast-delivery promises must be financially sustainable, not just popular with customers.
Not Competitive
A business may fail when it cannot attract and retain enough customers compared with its rivals. Its products may be less appealing, its costs may be too high, or its marketing and management may be ineffective.
New Entrants
A new competitor may offer better quality, lower prices or products that meet changing customer preferences. For example, Nokia lost competitive ground as Apple and Android smartphones became more popular. Some smaller firms also struggle when larger rivals enter their markets.
- Competitors might develop superior products.
- They may identify customer demand more effectively.
- Lower costs may allow cheaper selling prices.
- A powerful rival might use aggressive discounting to gain market share.
Ineffective Cost Control
If a firm’s costs are too high, it may have to charge prices above its rivals or accept very low profits. It could be too small to obtain economies of scale, waste money because of weak budgeting, pay too much for inputs, or use expensive production methods. Exchange-rate movements can also make imported materials more costly.
For example, choosing a US$5,000 business-class airfare instead of a US$300 economy fare could create unnecessary costs. The illustration concerns cost discipline, not a recommendation about employee travel.
Ineffective Marketing
Poor market research, unsuitable prices, excessive or poorly targeted promotion, and unpopular products can cause sales to fall. For example, Colgate’s unsuccessful move into convenience foods illustrates the risks of introducing products that do not match customer expectations.
- Product: unpopular or unsuitable offerings fail to attract demand.
- Price: excessively high prices discourage buyers, while very low prices may undermine profits or signal poor quality.
- Promotion: expensive campaigns may fail to reach the intended audience.
- Strategy: television advertising may be less appropriate than targeted online marketing for some firms.
Lack of Business Skills
Running a firm requires financial, organisational, communication, IT, marketing, negotiation and decision-making abilities. Owners who lack these skills may mismanage money or make poor commercial choices even when their original idea was promising.
Poor Leadership
Senior managers can weaken a business through poor decisions, failure to respond to problems or a lack of clear direction. For example, UK retailer BHS collapsed in 2016 amid serious management and financial problems.
Kingfisher Airlines ceased trading in 2012 with debts reported as about 7,000 crore rupees. Its difficulties were linked to leadership instability, high operating costs from luxury services and promotion, and external factors such as fuel prices and taxes. It had previously become a market leader, showing that reputation and scale alone do not guarantee survival.
Worked example: assume the historical exchange rate Rs66 = US$1, with 1 crore equal to 10 million rupees. Thus Rs7,000 crore = Rs70 billion; Rs70 billion ÷ 66 ≈ US$1.06 billion, using this historical exchange rate.
Failure to Innovate
Some businesses fail because they continue offering old products or methods while technology and customer preferences change. Innovation can involve new products, improved production methods, new sales channels, better customer service or different business models.
- Product development: competitors may release more attractive new products.
- Production technology: failing to invest in efficient systems can leave costs above rivals.
- Online selling: retailers that do not respond to digital shopping may lose customers to more convenient rivals.
- Risk of standing still: delaying change can be dangerous, but investment must also be affordable and well planned.
BlackBerry struggled as the market moved towards touchscreen smartphones; Comet, a UK electrical retailer, failed to respond effectively to the growth of online shopping. Both show the danger of ignoring technological and consumer changes.
Evaluation: Business failure often results from connected problems such as costly expansion, heavy borrowing, weak leadership and failure to respond to online competition. It is too simplistic to blame only lack of finance or only failure to innovate. Managers need to evaluate the causes together.
Large vs Small Businesses
Businesses of all sizes may suffer cash shortages, weak marketing, poor leadership or failure to innovate. Large firms have often more finance, assets and staff expertise, so they may be better able to survive a downturn. However, they can also accumulate large debts and suffer serious problems.
Large businesses
- More likely to have access to several finance sources and specialist management.
- Can spread risk across products, locations or markets.
- Large borrowings or slow decisions may make recovery difficult.
Small businesses
- Often have less spare cash or security for loans.
- May struggle to match larger rivals’ economies of scale.
- May be able to change direction quickly, with fewer activities to reorganise.
Balanced judgement: size influences a firm’s ability to withstand difficulties, but the quality of its decisions, cash management, competitiveness and responsiveness to customers matters more than size alone.
End-of-chapter questions
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Identify four reasons why a business may fail.
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Examples include cash-flow problems, lack of finance, failure to compete, poor marketing, poor leadership, over-borrowing and failure to innovate.
Distinguish between overtrading and undercapitalisation.
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Overtrading means growing or producing too quickly without sufficient cash. Undercapitalisation means starting operations with too little capital to fund the business properly.
Explain how seasonal demand can cause a cash-flow problem.
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A firm may receive most of its income in peak months but still pay staff, rent or maintenance throughout the year, so it must budget for periods with little cash coming in.
Analyse how ineffective cost control could reduce competitiveness.
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Excessively high costs force a firm either to charge higher prices, which may lose customers to cheaper competitors, or to accept lower profits, reducing funds available for improvement.
Why might an established firm fail because of new entrants?
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A new rival may offer superior products, lower prices or more convenient ways of shopping, causing the established firm to lose market share and sales.
Explain one way weak marketing can cause business failure.
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An unsuitable product, inappropriate pricing or poorly targeted advertising can reduce demand while still adding costs, putting profit and cash under pressure.
Assuming Rs66 = US$1, calculate the dollar value of Rs7,000 crore of debt.
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One crore is 10 million rupees, so 7,000 crore = 70,000 million rupees. 70,000 ÷ 66 ≈ US$1,060.6 million, or US$1.06 billion.
Analyse two factors that contributed to Kingfisher Airlines’ failure.
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Its expensive luxury services and marketing increased operating costs; leadership problems and external fuel prices and taxes added pressure. Together these weakened profitability and finances.
Explain why refusing to introduce online sales can be risky for a retailer.
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Customers may switch to online competitors that are more convenient or cheaper, causing falling store sales and declining competitiveness.
Evaluate the view that lack of finance is always the main cause of business failure.
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A shortage of finance can stop a firm meeting its bills, but weak marketing, poor leadership, excessive costs and failure to innovate may cause the shortage in the first place. The main cause depends on the circumstances.
Are small firms always more likely to fail than large firms? Justify your answer.
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Small firms may have fewer cash reserves and finance options, but large firms can also fail through poor strategy, excessive debts or lack of innovation. Size matters, but management quality and adaptability are central to the judgement.
Chapter 15 recap
Businesses may fail because of cash-flow problems, lack of finance, loss of competitiveness or failure to innovate. Overtrading, weak leadership, high costs and an inability to respond to customers can reinforce one another. A business needs sufficient cash, realistic plans and the ability to adapt if it is to survive.
Independent revision notes and questions for Pearson Edexcel International GCSE Business (9–1). Historical business examples are for learning purposes and may not describe current company practices.