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Bankruptcy: 5 Common Causes of Small Businesses

Not all factors that affect business are controllable. However, as a small business owner, you can take steps to avoid bankruptcy and ensure long-term success. Here are the common causes of business failure and ways to help your business deal with them.

No entrepreneur expects his business to find itself in financial difficulties or insolvency. However, the Bankruptcy Review Board recorded 2,621 business bankruptcies in Canada in 2022, an increase of 35% compared to 2021. This is because running a small business is subject to factors over which you have some control and others that are beyond your control.

Having the right knowledge and implementing the right strategies can help you overcome internal and external challenges and build a successful business that will last for a long time.

Common causes of financial problems cited by business owners:

1. Unforeseen events and economic downturns

Business leaders cannot predict or control external events such as natural disasters, economic recessions or pandemics, but these events can have a devastating impact on their business. Your business plan should include scenario planning – anticipating different conditions that could affect your business and how you might mitigate their impact.

One option is to set up an emergency fund to stop riots in hard times. Set aside a portion of your profits to build an emergency fund to act as a financial cushion in case of unexpected expenses or an economic downturn. This fund can help you cover temporary deficits or avoid accumulating debt.

2. Illnesses, injuries or other health problems

If you’re an entrepreneur, no one can come to your rescue and do everything for you when you can’t work. In the case of many small business owners, if they cannot work, the business does not make money. It is important to have a plan to minimize the impact of illness on your business. If you can still work, think about what you can do safely. However, if you are no longer able to work, your contingency plan should include the necessary information so that a trusted person can manage your business in your absence or communicate with stakeholders about your temporary unavailability.

3. Insufficient cash flow

Imagine the following situation: your business is booming, sales are growing, and your products or services are in high demand. However, a lack of cash flow can undermine even the most promising businesses. It is therefore crucial to keep an eye on your finances and maintain a healthy cash flow.

Implement effective cash management strategies. For example, you can invoice faster, offer early payment incentives and negotiate favorable payment terms with suppliers.

4. Knowledge gaps in financial management

Entrepreneurship is not just about passion. With so much work to do, a business owner may neglect to track expenses, collect payments, or even create an overall budget. Over time, these deficiencies can accumulate and result in serious financial difficulties.

Consider hiring a qualified accountant, financial advisor, or business advisor to help you with finances, tax planning, and general business operations. It can also help you identify potential risks and opportunities.

5. Excessive borrowing and indebtedness

Debt is useful for business growth, but over-indebtedness can later turn into an unmanageable financial burden. Business financing is an important part of your business plan: before taking on debt, assess your ability to repay it and develop a realistic payment plan. Additionally, consider diversifying your funding sources (bank loans, grants, crowdfunding, etc.) to have additional resources while reducing the risk of relying solely on debt to finance your business.

Running a business requires careful planning, financial knowledge and a healthy dose of adaptability and resilience. To drive your business to long-term success, you’ll need to be aware of the mistakes that put businesses in financial trouble and take proactive steps to mitigate the risks.

This article is intended to provide general information only and is not intended to provide legal, financial or other professional advice. Please consult with a professional advisor regarding your specific situation. The information presented is believed to be factual and current, but we do not guarantee its accuracy and cannot be considered an exhaustive analysis of the topics discussed. Opinions expressed reflect the judgment of the authors as of the date of publication and are subject to change. Royal Bank of Canada and its entities do not promote, either explicitly or implicitly, the advice, opinions, information, products or services of third parties.

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