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Top Causes of Business Debt

Worried business owners calculating finances - Small restaurant

Businesses need substantial funds to operate. New businesses, especially, require a lot of investment right away in order to establish the basic structure of the company and for business operations. It’s easy for a new business to incur debt after debt, causing the company’s profits to decline and ultimately leading to bankruptcy. Below, we discuss some of the principal reasons why businesses might amass more debt than they can handle, which has caused them to fail despite a great idea. If you need assistance building your small business or are struggling with business debt in Southern California, call an experienced, dedicated Ventura business law attorney for assistance.

Poor Financial Management and Budgeting

Starting a business often requires a substantial investment for all parties involved. It’s easy to accumulate debt to cover a myriad of expenses–from equipment and inventory purchases to hiring, marketing, and other expenses. Even if a business is generating revenue, it’s easy to lose track of the company’s finances and spend recklessly with the intention to expand the business. It’s important to plan a budget ahead of time, determining how much of and which funds are to be used for the various aspects of the business.

Proper cash flow management includes forecasting earnings, monitoring accounts regularly, and calendaring payments that must be made. Avoid exorbitant expenses that do not serve the business, and make expenditures that make sense based on current and forecasted earnings. Regularly review accounts and earnings to make sure that new expenses or recurring expenses are not jeopardizing the company’s cash flow. Keep on top of invoicing and general accounting practices to avoid unnecessary mistakes that reduce cash flow, generate penalties with creditors, or otherwise cause issues.

Poor Planning

In addition to proper budgeting, proper planning can go a long way toward avoiding debt troubles. Before entering into a new market or developing a new product, for example, the company should do all appropriate research. Research might include identifying customer needs, the size of the potential customer base, the anticipated costs of developing, marketing, and selling the product, and other items.

Managers should familiarize themselves with finance and management, even if their background is in a different aspect of the industry (creative, tech, etc.). Develop a business plan with the help of financial and legal advisors, establish infrastructure and policies to handle day-to-day issues, and keep on top of customer needs, the market, and the behavior of creditors.

Lack of Financing

Many businesses fail within the first few years because they run out of money before they can even get a foothold in the market. Proper financing from the outset can give the business the time it needs to grow and lay down roots, generating a customer base and revenue stream that will carry forward. Trying to stretch minimal financing at the beginning is more likely to lead to the business failing to get off the ground while still incurring substantial debts that will need to be repaid.

Unfriendly Market Cycle

The best intentions or plans can be quickly eroded by a barren year, or even a particularly bad quarter. The devastating effects of a bad market cycle have been brutally demonstrated over the course of the COVID-19 pandemic. Even well-functioning businesses with established customer bases cannot avoid crushing debt when customers are physically unable to patronize the business. Other unexpected events, such as shifts in customer preference in niche markets or the emergence of a large corporate competitor, can also lead to unexpected underperformance.

Businesses must be able to adapt to changed circumstances and find ways to survive temporary setbacks. Examples of proactive responses to setbacks may include a reduction in overhead costs or making structural changes. Planning ahead by maintaining a rainy-day fund, carrying sufficient insurance, and investing in preventative measures can help a business adapt and endure difficult times. But, if a pattern of business losses continues, it may be better to consider a possible reorganization or wind up the business and move on to a new venture rather than continue to generate debt in the hopes of a revenue resurgence.

Seasoned Advice and Representation from a Southern California Business Law and Debt Relief Attorney

If you are forming a new business in California or if you need advice or assistance concerning any matter of California business law, contact Rounds & Sutter for sound legal advice and zealous representation.

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