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What Are The Most Common Reasons Small Businesses File Bankruptcy?

Small businesses exist on a constant financial precipice. For the first few years, most don’t register a profit, and those that survive the first few years often do so only by borrowing money or paying employees while foregoing a salary as an owner. Given this uphill battle, it should be no surprise that many small business owners end up filing for bankruptcy – but it doesn’t have to end that way.

If, as a business owner, you have a clear sense of what financial practices might put your business at risk, you can take steps to minimize your risks and to address potential problems proactively. Get started today by learning more about the 3 most common bankruptcy risks. This is the rocky terrain you’ll need to navigate in order to succeed.

Poor Accounting Practices

Does your small business have a bookkeeper or an accountant? If not, now is the time to hire one. While you may know how to balance a checkbook, to thrive in business, you need someone who understands management accounting, a niche part of the accounting field focused on financial best practices. 

Unlike other types of accounting, management accounting is for internal use only. It’s designed to help your business make smart, sustainable financial decisions; without it, you’re at greater risk of filing for bankruptcy. The sort of basic bookkeeping that monitors cashflow is important, but you need management accounting to help you do more than just keep your head above water.

Borrowing Too Much

Another common reason that small businesses declare bankruptcy is because they’ve borrowed too much money when getting started. How does this lead to bankruptcy? While companies that have overborrowed have no problem covering overhead, equipment, and other costs early on, they often find themselves unable to repay their loans. It’s a frustrating situation, since such companies often seem like they could succeed, if their loans weren’t sinking them – but sometimes bankruptcy can offer a second chance.

We often think about bankruptcy as the end of the road or a business, and in the case of Chapter 7 bankruptcy, it can be. However, companies that still have potential to thrive can take another path. By filing for Chapter 11 bankruptcy instead,  businesses have the opportunity to reorganize their operations. Though it’s a labor-intensive process for the business and their legal team, Chapter 11 bankruptcy offers a kind of second chance at success with careful oversight.

Taking Too Few Loans

Though borrowing too much money can put your business at risk of filing for bankruptcy, the opposite can be equally problematic. In fact, companies that take out too few loans when getting started often wind up in an even more precarious position than those who over-borrow. That’s because these companies have to cut costs everywhere and often don’t have the resources that they need to hire staff, advertise their services, and otherwise get their business off the ground. Later on once the business is up and running, businesses often struggle to cover their supplier costs, in which case purchase order financing is a great option. 

Businesses that under-borrow are far more likely to have to file for Chapter 7 bankruptcy, known as liquidation or straight bankruptcy. This requires you to dissolve your business entirely, but it also fully eliminates your debts. This is in sharp contrast to Chapter 11 bankruptcy, in which your debts remained, but are reorganized and paid off over time in a more manageable way. Understanding the different types of bankruptcy, then, can help you decide what types of measured risks you’d prefer to take as you start a business.

Launching a new company is inherently risky, and you will end up putting your time and money on the line. Still, it’s better to take that leap knowing what is at stake and how you can protect your business before you get started. Professional success is all about planning – are you ready.