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Managerial inadequacy is generally perceived as the major cause of small business failure.

Unfortunately, this term encompasses a very broad set of issues. It has been estimated that two

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thirds of small business failures are due to the incompetence of the owner-manager. [16] The

identified problems cover behavioral issues, a lack of business skills, a lack of specific technical

skills, and marketing myopia. Specifying every limitation of these owners would be prohibitive.

However, some limitations are mentioned with remarkable consistency. Having poor

communication skills, with employees and/or customers, appears to be a marker for

failure. [17] The inability to listen to criticism or divergent views is a marker for failure, as is the

inability to be flexible in one’s thinking. [18]


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Ask many small business owners where their strategic plans exist, and they may point to their

foreheads. The failure to conduct formal planning may be the most frequently mentioned item

with respect to small business failure. Given the relative lack of resources, it is not surprising

that small firms tend to opt for intuitive approaches to planning. [19], [20] Formal approaches to

planning are seen as a waste of time, [21] or they are seen as too theoretical.[22] The end result is

that many small business owners fail to conduct formal strategic planning in a meaningful

way. [23], [24] In fact, many fail to conduct any planning; [25], [26] others may fail to conduct

operational planning, such as marketing strategies. [27] The evidence appears to clearly indicate

that a small firm that wishes to be successful needs to not only develop an initial strategic plan

but also conduct an ongoing process of strategic renewal through planning.

Many managers do not have the ability to correctly select staff or manage them. [28] Other

managerial failings appear to be in limitations in the functional area of marketing. Failing firms

tend to ignore the changing demands of their customers, something that can have devastating

effects.[29] The failure to understand what customers value and being able to adapt to changing

customer needs often leads to business failure. [30]

The second major cause of small business failure is finance. Financial problems fall into three

categories: start-up, cash flow, and financial management. When a firm begins operation (start-

up), it will require capital. Unfortunately, many small business owners initially underestimate

the amount of capital that should be available for operations. [31] This may explain why most

small firms that fail do so within the first few years of their creation. The failure to start with

sufficient capital can be attributed to the inability of the owner to acquire the needed capital. It

can also be due to the owner’s failure to sufficiently plan for his or her capital needs. Here we see

the possible interactions among the major causes of firm failure. Cash-flow management has

been identified as a prime cause for failure. [32],[33] Good cash-flow management is essential for

the survival of any firm, but small firms in particular must pay close attention to this process.

Small businesses must develop and maintain effective financial controls, such as credit

controls. [34] For very small businesses, this translates into having an owner who has at least a

fundamental familiarity with accounting and finance. [35] In addition, the small firm will need



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either an in-house or an outsourced accountant. [36] Unfortunately, many owners fail to fully use

their accountants’ advice to manage their businesses. [37]

The last major factor identified with the failure of small businesses is the external environment.

There is a potentially infinite list of causes, but the economic environment tends to be most

prominent. Here again, however,confusing appears to describe the list. Some argue that

economic conditions contribute to between 30 percent and 50 percent of small business failures,

in direct contradiction to the belief that managerial incompetence is the major cause. [38] Two

economic measures appear to affect failure rates: interest rates, which appear to be tied to

bankruptcies, and the unemployment rate, which appears to be tied to discontinuance. [39] The

potential impact of these external economic variables might be that small business owners need

to be either planners to cover potential contingencies or lucky.

Even given the confusing and sometimes conflicting results with respect to failure in small

businesses, some common themes can be identified. The reasons for failure fall into three broad

categories: managerial inadequacy, finance, and environmental. They, in turn, have some

consistently mentioned factors (see Table 1.5 “Reasons for Small Business Failure“). These

factors should be viewed as warning signs—danger areas that need to be avoided if you wish to

survive. Although small business owners cannot directly affect environmental conditions, they

can recognize the potential problems that they might bring. This text will provide guidance on

how the small business owner can minimize these threats through proactive leadership.

Table 1.5 Reasons for Small Business Failure

Managerial Inadequacy Financial Inadequacy External Factors

Failure in planning (initial start-up

plan and subsequent plans)

Inexperience with managing

business operation

Ineffective staffing

Poor communication skills

Failure to seek or respond to

Cash-flow problems

Insufficient initial capitalization

Inadequate financial records

Not using accountants’ insights

Inadequate capital acquisition


Failure to deal with financial

Downturn in economy

Rising unemployment

Rising interest rates

Product or service no longer

desired by customers

Unmatchable foreign




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Managerial Inadequacy Financial Inadequacy External Factors


Failure to learn from past failures

Ignoring customers’ needs

Ignoring competition

Failure to diversify customer base

Failure to innovate

Ineffective marketing strategies

issues brought about by growth Fraud


Ultimately, business failure will be a company-specific combination of factors. Monitor101, a

company that developed an Internet information monitoring product for institutional investors

in 2005, failed badly. One of the cofounders identified the following seven mistakes that were

made, most of which can be linked to managerial inadequa

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