A successful business is one that is profitable and sustainable but profitability alone is no guarantee of success. There are many stories of seemingly successful and profitable companies going out of business, but what causes profitable businesses to fail?
Your business is profitable if there’s money left over from your sales revenue after you’ve paid all your expenses. However, there are several reasons why a business might not be sustainable, despite being profitable. This blog uncovers some of the common reasons why profitable businesses can fail.
Poor Financial Management
Many of the fundamental issues that cause businesses to fail, even when they are profitable, stem from poor financial management.
Over-reliance on short-term profits at the expense of long-term sustainability
If you’re always chasing short-term gains, you may not fully consider the longer-term impact of social, economic and environmental factors affecting your company. When you focus efforts on short-term profitability, it gives you a big boost in turnover quickly. However, this can lead to decisions that aren’t well-thought-through. The negative consequences could be reduced customer and employee satisfaction, issues with compliance and governance and lack of investment in the business.
Mismanagement of cash flow and failure to plan for economic downturns
Businesses rely on cash to keep them working. Without sufficient available cash, you can’t pay your suppliers or staff, repay your investors or grow your company. Where many business owners go wrong is assuming that profit = cash.
As we’ve said, profit is the difference between sales and cost of sales. However, making a profit is not the same as having cash in the bank. If you don’t keep a close eye on how the cash is coming into and flowing out of your business, you can run into problems and run out of cash. Creating a cash flow forecast can help you avoid running out of money and having to close your business.
To create a sustainable business, you need to plan for times when your sales might be lower than average. When the economic environment is challenging, such as in a recession or prolonged period of low growth, it may be more difficult to retain and find new customers. This means your sales figures could drop off. If your cost base doesn’t reduce, this will eat into your profits. It will be harder to stay solvent if the situation isn’t quickly resolved.
Inefficient cost control and excessive spending
Profitable businesses can run into trouble if costs aren’t kept under control. Budgeting and variance analysis are key tools to help you understand where your costs are coming from. Using these tools ensures you give staff responsibility and accountability for managing costs to budget.
Lack of Innovation and Adaptability
Profitable businesses can fail because they don’t keep pace with the changing marketplace. If you don’t invest in creating the products and services of the future, your business will be left behind.
Stagnation in product/service offerings
Markets can change quickly and if you’re unable to keep up with your competitors’ innovations, you can become obsolete. An example of this is Blockbuster, the video rental chain which was a market leader in the 1980s-2000s. By 2010, Blockbuster filed for bankruptcy. It had failed to keep pace with new services such as video on demand and video mail order services from competitors such as Netflix.
Failure to keep up with industry trends and technological advancements
Technological advancements happen at a staggering rate these days. As far back as 1975 there’s clear evidence that businesses need to adapt and embrace new technology or die. Kodak, the market leader in photographic film, chose not to invest in digital cameras and film. This decision subsequently led to its downfall in 2012.
Ignoring changing customer preferences and demands
Customers are the lifeblood of any business. Without them, it doesn’t matter if you have the best product on the planet, you won’t have a successful business. Your business must focus on understanding and meeting your customers’ needs and desires. Businesses that ignore their customers’ preferences will ultimately pay the price, such as Blackberry, once the smartphone market leader. They decided not to embrace the ‘Bring Your Own Device’ trend and were superseded by Apple as the smartphone giant.
Ineffective Leadership and Management
Many great businesses have suffered from ineffective leadership. Growing a larger business with staff takes a different skill set than being a freelancer. Businesses can go wrong because they fail to understand the complexities of managing people and operating a larger organisation.
Lack of a clear vision and direction for the company
If you don’t have a clear plan for your company or if you can’t articulate your vision in a coherent way, you can end up in a mess where people are pulling in opposite directions. Your staff need to be working together for common goals or this could lead to duplication or omissions that impact your business finances.
Incompetent leadership unable to motivate and inspire employees
One of the biggest problems that businesses face is a lack of leadership resulting in chaos at the lower levels of the organisation. If it’s taking too long to get basic things done, this will impact your company’s productivity and profitability and it could ultimately result in an unsustainable business model.
Neglecting Customer Satisfaction and Retention
Profitable companies can end up in difficulties if they don’t pay enough attention to making their customers happy. We are quick to write bad reviews online when we receive substandard service and this can harm your business reputation leading to a drop in sales.
Focusing solely on acquisition while ignoring customer retention
It costs much more to find and close a new client than it does to get another sale from an existing customer. Some businesses become too focused on winning new customers rather than retaining the ones they already have. This eats into profits because they require larger and larger marketing budgets.
Poor customer service leading to negative word-of-mouth
Businesses that focus on providing the best customer experience are much more likely to create sustainable profitability than those who are looking to make a ‘quick buck’ from a customer and then move on to the next one. Negative customer feedback spreads quickly online which can turn a profitable business into one that is struggling to make enough sales to remain solvent.
Profitable businesses focus on knowledge and control
Are you worried about the cash position in your business? Can you make payroll next week and keep on top of your supplier invoices?
Furthermore, perhaps you would benefit from some tighter controls and reporting to spot the squeeze points in your cash flow? When you know in advance cash is going to be tight, you have time to mitigate the problem and find alternative ways to keep your business trading.
Sign up for your FREE trial of Numbers Knowhow. This revolutionary cash flow software will empower you with the numbers you need to maintain and improve your business profitability.
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