When your business enters bankruptcy, you may find yourself confused about the process or wondering how you ended up in this situation in the first place. If your business files for Chapter 7 bankruptcy, it means that your assets have been liquidated to pay off your debts. As you attempt to recover from this setback, it’s important to learn what went wrong so that you can use that knowledge to succeed next time around. Here are the top five causes of business bankruptcy, and the steps you can take to avoid these common mistakes.
Low capital
When it comes to business bankruptcies, it’s important to note that there are two categories: voluntary and involuntary. The latter is caused by events like litigation, natural disasters or changes in industry conditions. Voluntary bankruptcies, on the other hand, happen when a company fails to repay its debts (or loans) as agreed—also known as debt restructuring. There are a number of reasons for such failures and low capital is one of them.
When a company isn’t generating enough revenue to cover costs and expenses, it can turn away from investors and creditors for more money. Instead, look at ways you can cut down on overhead costs without sacrificing quality; streamlining processes might be all you need to stay afloat.
Poor management
Most business failures are due to poor management and bad financial decisions. Poor management can include poor planning, lack of motivation, or failing to communicate goals to employees or customers.
Failing to plan ahead or make wise decisions is usually what causes companies to file for bankruptcy. Making poor financial decisions can also result in failure due to loss of profits, insufficient capital, or a lack of cash flow. Inadequate funding may be caused by making too many risky investments and spending more than you have coming in. Lack of cash flow makes it difficult for a company that’s running out of money, but there are strategies business owners can use when they need additional funds in a pinch..
Market environment
High competition, lack of demand, poor supply control and aging infrastructure are some factors that can harm your market environment. These forces can adversely affect all aspects of a business and turn what once was a booming business into a bust.
Sometimes it’s a combination of these issues, but many times one issue is so overwhelming that it alone can take down your company. Consider, for example, if you open up shop in an area already saturated with companies just like yours. Without anything unique to draw people in, they’ll simply choose another establishment offering similar goods or services instead. This is known as over-saturation and happens when companies enter an industry before demand actually meets supply.
Bad luck
While there are certainly exceptions, it’s safe to say that most business bankruptcies are caused by bad luck rather than bad management. When new competition opens down the street, a major client decides to go with another vendor or an employee gets hit by a bus and is out for three months, you could lose hundreds of thousands of dollars in revenue. It may seem unfair, but that’s just how life works sometimes. And while building up enough cash reserves to survive a few lean months may sound like common sense, it’s not always easy to see impending problems on your way up. Consider self-insuring against business catastrophe.
Crime/fraud
The American Institute of Certified Public Accountants found that crime/fraud is not only among a business owner’s greatest fears, but it also leads to large-scale bankruptcies. In fact, more than half (54 percent) of business owners who were victims of crime admitted to filing for bankruptcy protection within two years. The majority of crime/fraud charges are related to embezzlement. An estimated $600 billion is lost to employee theft each year and it doesn’t take much for those losses to add up quickly: an estimated $8 out of every $10 given in tips goes back into employees’ pockets; one in 20 employees pilfer cash or inventory from their employer, and 6 percent admit to having stolen something from their job in any given week.
