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5. Understand that small business owners need to be able to formally plan and understand the

accounting and finance needs of their firms.

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There are no easy answers to questions about success and failure in a small business. The

different points of view are all over the map.

What Is a Successful Small Business?

Ask the average person what the purpose of a business is or how he or she would define a

successful business, and the most likely response would be “one that makes a profit.” A more

sophisticated reply might extend that to “one that makes an acceptable profit now and in the

future.” Ask anyone in the finance department of a publicly held firm, and his or her answer

would be “one that maximizes shareholder wealth.” The management guru Peter Drucker said

that for businesses to succeed, they needed to create customers, while W. E. Deming, the quality

guru, advocated that business success required “delighting” customers. No one can argue,

specifically, with any of these definitions of small business success, but they miss an important

element of the definition of success for the small business owner: to be free and independent.


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Many people have studied whether there is any significant difference between the small business

owner and the entrepreneur. Some entrepreneurs place more emphasis on growth in their

definition of success.[1] However, it is clear that entrepreneurs and small business owners define

much of their personal and their firm’s success in the context of providing them with

independence. For many small business owners, being in charge of their own life is the prime

motivator: a “fervently guarded sense of independence,” and money is seen as a beneficial by-

product. [2], [3], [4]Oftentimes, financial performance is seen as an important measure of success.

However, small businesses are reluctant to report their financial information, so this will always

be an imperfect and incomplete measure of success. [5]

Three types of small business operators can be identified based on what they see as constituting


1. An artisan whose intrinsic satisfaction comes from performing the business activity

2. The entrepreneur who seeks growth

3. The owner who seeks independence [6]

When discussing failure rates in small business, there is only one appropriate word: confusion.

There are wildly different values, from 90 percent to 1 percent, with a wide range of values in

between. [7] Obviously, there is a problem with these results, or some factor is missing. One

factor that would explain this discrepancy is the different definitions of the termfailure. A

second factor is that of timeline. When will a firm fail after it starts operation?

The term failure can have several meanings. [8] Small-business failure is often measured by the

cessation of a firm’s operation, but this can be brought about by several things:

• An owner can die or simply choose to discontinue operations.

• The owner may recognize that the business is not generating sufficient return to warrant the effort that is

being put into it. This is sometimes referred to as the failure of opportunity cost.

• A firm that is losing money may be terminated to avoid losses to its creditors.

• There can be losses to creditors that bring about cessations of the firm’s operations.

• The firm can experience bankruptcy. Bankruptcy is probably what most people think of when they hear

the term business failure. However, the evidence indicates that bankruptcies constitute only a minor

reason for failure.



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Failure can therefore be thought of in terms of a cascading series of outcomes (see Figure 1.1

“Types of Business Failures”). There are even times when small business owners involved in a

closure consider the firm successful at its closing. [9] Then there is the complication of

considering the industry of the small business when examining failure and bankruptcy. The

rates of failure can vary considerably across different industries; in the fourth quarter of 2009,

the failure rates for service firms were half that of transportation firms. [10]

Figure 1.1 Types of Business Failures


The second issue associated with small business failure is a consideration of the time horizon.

Again, there are wildly different viewpoints. The Dan River Small Business Development Center

presented data that indicated that 95 percent of small businesses fail within five years. [11] Dun

and Bradstreet reported that companies with fewer than twenty employees have only a 37

percent chance of surviving four years, but only 10 percent will go bankrupt. [12] The US Bureau

of Labor Statistics indicated that 66 percent of new establishments survive for two years, and

that number drops to 44 percent two years later. [13] It appears that the longer you survive, the

higher the probability of your continued existence. This makes sense, but it is no guarantee. Any

business can fail after many years of success.

Why Do Small Businesses Fail?



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There is no more puzzling or better studied issue in the field of small business than what causes

them to fail. Given the critical role of small businesses in the US economy, the economic

consequences of failure can be significant. Yet there is no definitive answer to the question.

Three broad categories of causes of failure have been identified: managerial inadequacy,

financial inadequacy, and external factors. The first cause,managerial inadequacy, is the most

frequently mentioned reason for firm failure. [14] Unfortunately, it is an all-inclusive explanation,

much like explaining that all plane crashes are due to pilot failure. Over thirty years ago, it was

observed that “while everyone agrees that bad management is the prime cause of failure, no one

agrees what ‘bad management’ means nor how it can be recognized except that the company has

collapsed—then everyone agrees that how badly managed it was.” [15] This observation remains

true today.

The second most common explanation cites financial inadequacy, or a lack of financial strength

in a firm. A third set of explanations center on environmental or external factors, such as a

significant decline in the economy.

Because it is important that small firms succeed, not fail, each factor will be discussed in detail.

However, these factors are not independent elements distinct from each other. A declining

economy will depress a firm’s sales, which negatively affects a firm’s cash flow. An owner who

lacks the knowledge and experience to manage this cash flow problem will see his or her firm


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