In the USA, about one-fifth of small business startups fail within the first year, and almost half of them fail within five years according to statistics of Small Business Administration (SBA)
I work as a business consultant in Denmark. Here the failure rate of small business is even higher. The Danish Industry says, 28% of small starts up fail within the first year. Half of the startups disappear within five years.
It also is observed that very few small businesses fail after they have survived for 5/6 years.
Small businesses fails in the start phase. Those fail before these start earning.
Small startups are very vulnerable to the initial stage. If a business can survive the initial hurdles, the chance of survival becomes much better. Typically, when a company can somehow hold on a year, the chance of its survival is enhanced.
I provide consultancy to small business owners in Denmark.
There are many reasons for failures but as I have experienced that the core reason for failure is inadequate cash reserves.
If an entrepreneur does not have sufficient cash to carry an establishment until it starts making money, the chance to survive is not good.
Many startup entrepreneurs have a wrong assessment of required capital. They often try to do establishment budget themselves and make vital mistakes.
They calculate the expenses to start a business but do not calculate the operational costs to run the business for many months before they there is any cash inflow. They pretend as if they will start making money from the very first day.
Whey they have money for buying machinery and inventory as well as the deposit for a rental contract, they start the business.
Many start business without understanding cash flow. New business owners often underestimate how much money they will need for operational costs.
Let’s say X wants to open a cloth shop. X has enough money to give the deposit for a rental place. X also has the cash for machinery and electricity installation. He also has money for buying inventory.
Now X has now started a business. But he does not get a customer. X has a good display of quality products at shop and prices are reasonable. But people don’t know that.
He does not have money to promote the business. Now one month has gone without earning, X has to pay rents, bills, and salaries. X can manage one months or two. In this situation, X has no option but to close the business.
In this way, startups fail. Those fail before they have earned any money. Even a small business needs planning, market strategy, and a realistic start budget.
Small business owners try to do these things themselves; they do not hire professionals for those tasks. They go bankrupt in the effort of saving consultant fees.
Many small business owners whom I have talked to, do not understand how to promote their business and how much it cost. They think customers will come to them if they have good products. This kind of old days thought cost their business.
Let me give an example from my real life experience. An entrepreneur located in London asked for my help to start a restaurant in Copenhagen. He had good experience in the restaurant business. He knew all that was needed to run a successful restaurant business.
He calculated the cost of overtaking rental places, machinery, and inventory. He had the cash for that. But he did not include operational costs in his budget.
I wrote a business plan and made a budget for him. My budget showed that he would need more cash than that he calculated initially. I told him that he must have enough money for operating cost for at least six months taking it in mind that he would not earn money in this period.
He did not have that much cash. He wanted to open the restaurant right anyway. He thought that customers would come from the beginning.
I advised him not to start the business unless he had adequate liquidity. I advised him to contact a bank with the plan and budget to apply for a loan or overdraft. If he did not get that, he should not start the business at all.
He followed my advice. The bank was satisfied with the plan and market strategy. He got help from the bank.
He started the restaurant as planned. He did all he could but did not get many guests in first 3 / 4 months. But he did not compromise with service and quality of his restaurant.
His cash was burnt up within a couple of months, but he could keep going using bank credit. From the fifth month, his business started running. He never had to look back ever since. Now, his restaurant is now one of the best in the town.
He has realized that his business would collapse within some months if he had started the business without having sufficient liquidity. Instead of the success, he has today, his could have been bankrupt.
To start a business without sufficient capital could be suicidal.