Common reasons for business failure

2008-10-20 00:00

As a child, I was told that the process of dying starts from the moment we are born. I suppose the same could be said about business. There could be many reasons for this, but a number of these recur so regularly they could be called common reasons for business failure. Here are a few:

•Too low a level of operating gross margin

If there is a number-one contender for business failure, this is it. Whenever I’m called to look at a business’s operating performance, the first variable I evaluate is the gross margin —both in rand value and percentage.

If these are wrong, everything is wrong. Gross margin is the lifeblood of a business. I am not saying turnover is unimportant, but rather that the gross margin value of that turnover is vital to profit generation.

• Too high a level of fixed costs

These are the costs that have to be paid every month; whether or not you sell R1 of goods or service. They are always there and include all the costs we sometimes call overheads: rent, rates, telephones, salaries, motor vehicles, etc.

The higher the fixed-cost base, the more gross margin your business will need if it is going to make a profit. Conversely, the lower the fixed-cost base, the greater the potential for profit.

•Too high a level of breakeven

Gross margin and fixed costs are at the heart of the breakeven formula: fixed costs divided by the gross margin percentage equals the turnover required to break even.

If your company’s breakeven number is “unprofitably high”, the day-to-day existence of your business will be extremely stressful and could easily become unsustainable.

If your business operates in a highly competitive market, it is in your interests to have the lowest possible breakeven level.

• Heavy investments in anticipation of growth that does not mature quickly enough

I can hear the bank manager saying: “They put far too much money into a new plant and machinery. The market was bound to turn down sooner or later.”

The lesson here is that as soon as a cost is put in place, the existing gross margin has to pay for it. The important point is “as soon as”. While the investment (cost) is not producing any enhancement to the gross margin levels, it is impacting negatively on profitability and cash resource.

• Reliance on borrowings to fund working capital needs

If your business is persistently relying on borrowed money to fund its day-to-day cash needs (working capital) via an overdraft, it indicates that your current operating performance is not sufficiently profitable.

Unless something is done to change the course the business is on, which will result in improved profit performance, the business will constantly be looking for additional borrowings — until the time when the bank says ‘No more!’.

The point to remember is that not only will the business have to pay interest on borrowings, it will also have to repay the capital. This can be achieved only by a profitable business.

• A totally inward-looking business

If a lack of gross margin is my number one, this would be my number two reason for business failure.

A prerequisite for business success is that it has to recognise the need to provide quality service and responsiveness in all customer dealings.

If, for whatever reason, the business takes its eye off the market and the customer, tomorrow will be very difficult in terms of profit generation.

In many ways, we are talking about the tail wagging the dog — the systems having become more important than the goal.

The consideration can be evaluated from many perspectives — an owner who thinks he can play golf every day and that the business will look after itself, for instance, or an apathetic workforce.

Next week I shall evaluate the considerations that come together to produce a highly successful business that won’t die at the first sneeze.

frankgreenfield@iafrica.com

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