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5 Common Causes of Small Business Bankruptcy

By Diane Amato

Published July 12, 2023 • 3 Min Read

No entrepreneur plans to see their business in financial trouble or facing insolvency, but the Office of the Superintendent of Bankruptcy reported 2,621 business bankruptcies in Canada in 2022 — up 35 per cent from 2021. That’s because running a small business means you’re affected by controllable factors and some beyond your control.

Having the right knowledge and strategies in place can help you navigate both internal and external challenges and build a thriving business that stands the test of time,

Common causes cited by business owners for experiencing critical money issues:

1. Unforeseen events and economic downturns

Business owners can’t predict or control external events — like natural disasters, economic recessions or pandemics, but these can devastate a business. Part of your business plan should include scenario planning — envisioning possible conditions that could affect your business and how you might be able to mitigate them.

One option to consider is maintaining an emergency fund to help weather the storm during challenging times. Set aside a portion of your profits as an emergency fund to provide a financial buffer in case of unexpected expenses or downturns. This fund can help you bridge temporary gaps and avoid accumulating debt.

2. Illness, injury, or health-related problems

As an entrepreneur, no one can step in and do everything you do if you can’t work. And for many small business owners, if they can’t work, the business doesn’t make money. It’s important to have a plan in place to help minimize the impact of illness on your company. If you can still work, evaluate what you can do safely. Still, if you can’t, your contingency plan should include the necessary information so that someone you trust can run your business temporarily or communicate with stakeholders about the temporary disruption.

3. Insufficient cash flow

Picture this: your business is thriving, sales are soaring, and your products or services are in high demand. However, despite the apparent success, inadequate cash flow can swiftly bring down even the most promising ventures. Keeping a close eye on your finances and maintaining a healthy cash flow is crucial.

Implement effective cash flow management strategies such as invoicing promptly, offering incentives for early payments, and negotiating favourable payment terms with suppliers.

4. Gaps in financial management knowledge

Managing a business entails more than passion. With everything a business owner has to do, it’s possible to deprioritize tracking expenses, chasing payments, or even overall budgeting. Over time these can add up and produce can lead to severe financial distress.

Consider working with a qualified accountant, financial advisor, or business consultant who can provide guidance on financial matters, tax planning, and overall business operations. They can also help you identify potential risks and opportunities.

5. Excessive debt and borrowing

Debt can be a useful tool for business growth, but excessive borrowing can create a financial burden that later becomes impossible to manage. Part of your business plan includes financing your enterprise: Before taking on debt assess your ability to repay it and develop a realistic repayment plan. Also, consider diversifying your funding sources — bank loans, grants, crowdfunding, etc. — to help provide additional support and reduce the risk of relying solely on debt to finance your business.

Running a successful business requires careful planning, financial insights, adaptability, and resilience. You can steer your business toward long-term success by staying aware of how businesses get into financial trouble and by taking proactive measures to mitigate risks.

This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.

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