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Business Bankruptcy – Identifying the Main Causes and Avoiding this Outcome

business bankruptcy

Sadly, nearly half of all small businesses in South Africa were forced into liquidation by the end of 2020, when social and trading restrictions due to the Coronavirus pandemic had been at their hardest. The numbers are startling but the most sobering reality of all is that up to fifty percent of small businesses fail within two years of starting up in South Africa, with that figure rising to between seventy and eighty percent within five years. Business bankruptcy is therefore reality – but by understanding what goes wrong, and what can be done to mitigate business money mistakes, you can put yourself in a better position to succeed as a business owner.

What causes a business to go bankrupt? 

The causes can broadly be classified into two segments – external factors and internal factors.

External factors will largely be beyond your control and include large scale weather or other disasters causing temporary closure or loss of clientele (for example, the COVID-19 pandemic), macroeconomic conditions, such as an unfavourable framework for obtaining finance or unforeseen changes to tax law; or incidental work-related incidents, such as lawsuits or insurance claims not being paid out. 

You have more control over the internal factors typically leading to liquidation. Weak corporate governance, bad management, weak or improper accounting procedures, staffing and payroll issues, and cash flow management and projection all fall into this category.

Research has shown that appointing a professional business advisory team or consulting with such a management team from time to time can make all the difference.

The main money mistakes made by small-to-medium enterprises

Here are some of the most critical money missteps:

  • Not having a proper business plan, nor consulting a professional in helping you to set up one. Even at this stage, make sure you have a team who can play the necessary oversight or ‘check-in’ role on matters such as corporate tax, VAT, tax savings for small businesses, correctly counting the cost of expenses and operational costs and making sound cash-flow projections.
  • Lack of budgetary planning and / or not setting up proper accounting procedures – however basic – from the outset. Your actual running costs must be close to your projected ones, or you’ll quickly run out of cash. The same will happen if you engage in amateur or ‘weak’ accounting procedures.
  • Starting up without enough capital, or the ability to generate it. This feeds into the above. It is a very common issue experienced by small businesses, and often the business owners that have ‘made it’ report not having dropped everything to start their business. Rather, they embarked on it as a ‘side gig’, so that they’d have some source of funding to keep both themselves and the business going. It cannot be overstated that these owners also often report having done research and consultation with professional tax, accounting and corporate law management teams during the incubation phase, as a start.
  • Buying too much inventory too soon, bad working capital management.
  • Having adequate funding, but managing and earmarking it for spending incorrectly. 

Seeking advice relating to financial management, corporate law, tax consulting, business accounting and company structuring is not the preserve of large corporations alone. As a business owner, if you run into choppy waters, you will typically have to find more bridging finance, default on your loans or file for bankruptcy. Unfortunately, in South Africa, the latter is all too often the outcome when it could have been prevented with better planning and overall management oversight (involving consulting a professional team), particularly in the beginning.