5 Common Causes of Small Business Bankruptcy

Steering Clear of Small Business Bankruptcy: The 5 Common Pitfalls

No business owner commences their entrepreneurial journey envisioning their venture grappling with financial difficulties or on the verge of bankruptcy. However, statistics from the Office of the Superintendent of Bankruptcy highlighted a surge of 35% in business bankruptcies in Canada in 2022, totaling 2,621 cases. Running a small business involves navigating both controllable and uncontrollable factors.

Equipping yourself with the right knowledge and strategies can help you steer through these challenges, fortifying your business to weather the test of time. Here are the 5 Common Causes of Small Business Bankruptcy and how to avoid them:

1. Unexpected Events and Economic Recession

Preparing for the Unpredictable

Business owners often find themselves at the mercy of external factors such as natural disasters, economic downturns, or even pandemics. These unforeseen events can wreak havoc on a business’s financial health. To mitigate the impact of these events, scenario planning should be an integral part of your business strategy.

The Role of an Emergency Fund

One practical approach includes setting up an emergency fund that can provide a financial cushion during challenging times. Allocating a part of your profits into this fund can help you cover unexpected expenses or downturns, thereby avoiding the need to accumulate debt.

2. Health-related Problems

The Impact of Health on Business

As an entrepreneur, your health plays a crucial role in the running of your business. If you are unable to work due to illness or injury, it can significantly impact your business’s operations and cash flow. Therefore, it’s crucial to have a contingency plan in place to deal with such situations.

Crafting a Contingency Plan

If you are still able to work, evaluate the tasks that you can safely perform. However, if unable to work, your contingency plan should outline necessary information so that a trusted person can temporarily take the reins of your business or communicate with stakeholders about the disruption.

3. Insufficient Cash Flow

The Illusion of Success

A common pitfall that can lead to small business bankruptcy is poor cash flow management. A business might appear to be thriving on the surface with soaring sales and high demand for its products or services. However, behind the scenes, inadequate cash flow can quickly cause even the most promising ventures to crumble.

Strategies for Healthy Cash Flow

Implementing effective cash flow management strategies such as prompt invoicing, incentives for early payments, and negotiating favorable payment terms with suppliers can help maintain a healthy cash flow.

4. Lack of Financial Management Knowledge

More than Passion

Running a successful business requires more than just passion. As a business owner, you might overlook crucial tasks like tracking expenses, collecting payments, or budgeting. Over time, these can accumulate and lead to severe financial distress.

Seeking Professional Assistance

Consider engaging with a qualified accountant, financial advisor, or business consultant. They can provide valuable guidance on financial management, tax planning, and overall business operations, helping you identify potential risks and opportunities.

5. Excessive Debt and Borrowing

The Double-edged Sword of Debt

Debt can serve as a tool for business growth, but excessive borrowing can lead to an unmanageable financial burden, a common cause of small business bankruptcy. It’s crucial to assess your repayment capability and chalk out a realistic repayment plan before taking on debt.

Diversifying Financing Sources

Diversifying your financing sources can also be beneficial. Explore options like bank loans, grants, crowdfunding, and more to reduce the risk of relying solely on debt to finance your business.

Running a successful business requires careful planning, financial acumen, adaptability, and resilience. By understanding the common causes of small business bankruptcy and taking proactive measures, you can steer your business towards long-term success.

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