The business failure rate is a scary score for small and medium-sized businesses. Some of the experts say that about 905 of the small businesses fail in the first year of their onset. On the other hand, almost 50% of them fail in the next year. The entrepreneurial community will reveal several similar claims and stories of the business that faced failures in the initial years.

But is this failure rate really should influence your decisions as an entrepreneur?

The Bureau of Labour Statistics (BLS) says a different story. As per its study, an approximate of 20% of the small and medium-sized businesses fails even before completing one year. Some of the business fails at the end of the third year. About half of them will fail at the end of the fifth year. And as some of them reach a decade, only 30 per cent of them are able to make it through the market. All this indicates a 70 per cent failure rates of the businesses.

The failure rate is identified and determined with the help of several data which use some of the most common variables. Some of them are as under:

• Failure: The statistics developed by the BLS is developed on the basis of data collected from a limited number of business. It states that when a business is no longer operational after one year of its onset is said to be a failure. However, there are several reasons that can be said as responsible for its closure. For instance, the owner simply wants to retire by closing the business and do not want to sell it to someone else. Such a case is not a fair way to make it count as a failure.
• Annual Variance: There is a certain variance from year to year, which is dependent on economic conditions. All the data which is presented here is applied to the businesses that is studied around 2007 and 2017. Many of these statistics remain relatively consistent, still, we can see variations in the failure rate within a year between 15 to 25 per cent.   
• Outlier Events: Some of the most significant outlier events can change the failure rate to a great extent. For instance, the onset of the COVID 19 pandemic created difficult financial conditions for businesses such as restaurants, bars, and nightclubs which involves close physical contact of the people with one another.
• Industry Variance: The startup failure rate varies significantly from one industry to the other. For instance, the businesses operating in the healthcare sector faced a much lower failure rate as the pandemic created a higher demand for the health care workers in the market.
• Conversely, the market is witnessing a higher failure rate in businesses such as travel and transportation. The most probable reason is the higher start up cost and a highly competitive market place.
• Statistics: The failure rate statistics presented cannot be said as accurate as some of the businesses are operating in secret and are not even counted in the reporting process.  

Why is Failure Rate Really Important?

Some of the people treat the failure rate as a tool to discourage the young entrepreneurs showing them how dangerous it is to start a business. However, the same failure rate can be studied to determine valuable insights.

The failure rate tells you about how and when the businesses fail. It was found that only 20% of the businesses fail within the first five years of their onset. In addition, 50 per cent of them fail within the first five years of their journey. Or, it can be said that an addition of 30 per cent of the businesses will fail between the second and the fifth year, which is about 7.5 per cent of the initial number per year.

If this 7.5 per cent rate of failure is counted as “death by natural causes” and count this number as the predictable rate of failure, it can be assumed that about 12.5 per cent of the business in the first year face a failure due the lack of preparation by their business owners.

The failure rate is also useful to calculate risk, especially, the overconfidence effect makes us optimistic. The failure rates, in such cases, help the small and medium business owners to become realistic and pragmatic.

The failure rates help the bui8sness owners to distribute their investments in such a way that they do not face a rapid failure. Moreover, these failure rates will help the small and medium businesses to plan and organize their business operations in such a way that the business does not experience a risk of failure.

Why are Failure Rates overestimated?

The rate of small business failure is often overestimated or misinterpreted. The rate is most of the time inflated as people most of the time exaggerate the rate of failure in the case of a small business. This is one of the shortest ways to change business expectations. These statistics are also used to discourage small and medium business owners from working for their business. However, people must use these statistics cautiously to know about the different aspects of business ownership.

Small businesses have a greater chance of failure, and the small business owners must be well aware of the reasons. However, the important thing is, to take the statistics for what they are, to understand the business context. These rates and statistics must never discourage the small business owners, and rather inspire them to keep a regular health check-up for their business.

Source – Forbes