Forecasting the Failure of a Business
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Forecasting the Failure of a Business

By forecasting the failure of a business, inefficient and poorly-managed firms can avoid incurring large losses. There are several characteristics and factors which affect the prospects of businesses. Management is seen as the culprit for the failure of the business due to their ability and experience. There are also reasons perceived by bankrupts for the failure of their business.

The ability to predict corporate failure is very important from both the private and the social points of view, since failure is obviously an indication of resource misallocation. An early warning signal of probable failure will enable both management and investors to take preventive measures. Changing the company’s policies, reorganisation of the financial structure and even voluntary liquidation will usually shorten the length of time for which losses are incurred. The main advantage of company failure prediction is the weeding out of inefficient and poorly-managed firms, thereby increasing competition and innovation.

The definition of failure is rather broad and ambiguous. To sum it up, it refers to a situation known as technical insolvency where a firm is unable to meet its maturing obligations. Others restrict the term to so-called ‘real insolvency’ cases where the total value of the firm’s assets is smaller than the total value of the liabilities (the company has high gearing). Sometimes business failure is interpreted in the strict legal sense of bankruptcy or liquidation, where the firm ceases its operations.

In a study by Dun and Bradstreet, the characteristics of failed companies were identified and the frequency of failure as a result of such characteristics was found. The first characteristic is Age. Many companies, which amount to around 75%, fail in their first five years of operation, and those older than ten years are also highly susceptible to failure unless they adapt to the changing conditions of the market. The Size of the firm also affects its likelihood of failure, as large companies normally have enough reserves to cushion losses for longer periods.

The third characteristic is Industry. In fact, 45% of failed companies in the United States at the time of the study were in the retail industry, 18% in the manufacturing industry and 14% in the construction industry. It was found that management has the strongest influence on whether a company fails or whether it prospers. 93% of all failures were attributed to wrong management, where 47% of failures in the US were due to management incompetence, 18% were due to unbalanced experience on the Board of Directors, 16% were due to lack of managerial experience, and 12% were due to the lack of experience of management on the line of business. Very minor causes of failure apart from management were neglect (2%), fraud (1%) and disaster (1%).

In another study by John McQueen entitled ‘Categories of Bankrupts’ which was performed in the Association of Bankrupts, the reasons perceived by bankrupts leading to the failure of their business were bad luck (10%), born losers (20% - most of which had set up the business in desperation or as a result of long-term unemployment), and tax reasons (50%).

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Comments (1)

Excellent performance Braden. Appreciate you and seek your friendship and support.