When looking at small business failure rates, it is essential to realize that business owners control their destiny. For example, the foodservice industry has a 30% failure rate; this does not mean opening a restaurant is like betting on black at the roulette table. Instead, it indicates that a business owner must make better, more informed business decisions to avoid becoming another statistic. Typically, these business decisions are proactive and data-driven, focusing on controllable factors, such as tax compliance, budget allocation, and supply-chain management, while also attempting to mitigate variables outside of this realm of control, such as large-scale economic trends.

What is the Small Business Failure Rate?

The COVID-19 Pandemic has been devastating to small businesses, with 200,000 additional closures in 2020. In non-pandemic times, however, the failure rates remain consistent year to year; even in years of poor economic performance, the failure rate varies little. According to the U.S. Bureau of Labor Statistics, just over 20% of small businesses will fail within their first year of operation. By year two, just over 30% will have shuttered. After five years, only half will still be in business. And by the decade mark, two-thirds of small businesses will have ceased operations.

As the statistics show, a small business’s first year is its most treacherous — and as a business survives each year, its likelihood to survive the next increases. Interestingly, this pattern holds regardless of industry; barring extraordinary circumstances (like a global pandemic), there are no industry-specific survival bottlenecks.

While the survival pattern is consistent across industries, upon analyzing the Census Bureau’s Business Dynamics Statistics, it is clear that the actual survival rates can vary significantly between sectors.

Related Reading: Small Business Tax Preparation

Small Business Failure Rate by Industry

Let’s take a look at some industry failure rates:

Information Industry

Consisting of many different sub-industries, including information products, information services, information devices, and information distribution, the information industry features a constantly shifting business landscape that necessitates a highly proactive approach to managing business operations. While potentially lucrative, the information industry’s 5-year failure rate stands at a whopping 63%.

Construction:

Despite the constant demand for new builds, the high overhead, lack of cash flow security, and the ongoing battle for new contracts make the construction industry especially brutal for newcomers. While a plucky business owner can overcome the odds with the help of a sharp accounting team, the 5-year failure rate for fledgling construction businesses tops 64%.

Manufacturing:

A broad and highly varied industry, many variables come into play when operating a manufacturing business — some of which lie outside of your control. For manufacturing business owners, staying on top of global and local economic and supply-chain trends coupled with impeccable financial reporting is crucial for informing business decisions. Nevertheless, 51% of new manufacturing businesses shut their doors within five years of commencing operations.

Food Service:

Despite the ever-prevalent notion that food service is high-attrition and cutthroat, opening a food establishment is one of the less risky business ventures on this list. In addition, it is one of the most merit-friendly industries around — although possessing good business acumen is still essential for success. After five years, about 50% of new restaurants and bars can expect to remain in business.

Finance and Real Estate:

While most industries’ closure rates are somewhat unaffected by economic downturns, the same cannot be said for finance and real estate. Businesses in this sector provide ample opportunity for massive earnings and easy scalability, but at a cost — no business owner can control the markets. And when the markets dip, portfolios can go belly-up. The five-year outlook for new finance and real estate businesses is risky — just under 60% will fail.

Healthcare and Social Services:

While somewhat challenging to break into, the healthcare and social services industry couples decent stability with ample room for growth — the Bureau of Labor Statistics’s projected 21% growth rate leads all other industries. As far as failing — well, it’s a definite possibility. However, the healthcare and social services industry is incredibly immune to macroeconomic struggles. As is the case in any industry, survival is contingent on proactive, data-driven business decisions. Still, the five-year outlook is pretty good: only 40% of new healthcare and social services businesses are projected to fail before the half-decade mark.

Why Do Small Businesses Fail?

There are a plethora of reasons why a small business might fail. Some fall on the owner’s shoulders, while others can be attributed to strokes of bad luck. According to a study by CB insights analyzing failed companies, the primary causes of failure could be attributed to

• Lack of demand in the marketplace — 42%
• Cashflow issues — 29%
• Personnel-related issues — 23%
• Defeated by a competitor —19%
• Price point issues — 18%
• Product issues — 17%
• Lack of a business model — 17%
• Poor marketing — 14%
• Legal challenges — 8%
• Poor Business Credit — 8%
• Lack of advisors — 8%

Put simply, there is no single factor that can make a company fail — it is often a nexus of many different factors, both within and outside a business owner’s realm of control. And while there is no silver bullet in business, many of the aforementioned downfalls can be mitigated — or entirely circumvented — by employing a dedicated team of accounting and bookkeeping professionals. Dedicated small business accountants, such as the experts at FinancePal, utilize data-driven analysis to inform proactive, effective business decisions. 

Meanwhile, specialized small business bookkeepers can ensure that your business has high-quality financial data to use as a roadmap. Together, specialized accountants and bookkeepers can help your business avoid cash flow, price point, and business model-related issues while enhancing your company’s ability to compete in the marketplace.

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What Is Forensic Accounting?

Put simply, forensic accounting is a special type of accounting related to current or anticipated litigation and disputes. Accountants conduct forensic accounting under the knowledge that their findings will be used in court — hence, “forensic” — when the court wants to determine damages. For example, during litigation over a compensation dispute, the court may utilize a forensic accountant as an expert witness.

Forensic accounting has its uses beyond litigation; criminal courts may utilize forensic accountants in cases of fraud or embezzlement.

What Do Forensic Accountants Do?

Using a combination of accounting, auditing, and investigative skills to analyze and interpret complex financial variables, forensic accountants seek to trace funds, identify and recover assets, and establish damages from claims. Forensic accountants also may quantify non-transactional damages, such as those arising from non-disclosure agreement breaches or trademark infringements. During divorce litigation, a forensic accountant may scrutinize financial transactions to uncover hidden assets or violations of contract.

Forensic accountants must be comfortable with public speaking and preparing and presenting data; as previously mentioned, a forensic accountant may be called upon in court as an expert witness. The accountant must aggregate and analyze data before synthesizing it into an easily understandable visual aid when this happens. Then, during the court date, the accountant must present this data in a concise and easily digestible manner.

Related Reading: Catch-Up Bookkeeping Services

What Industries Use Forensic Accountants?

There are several industries that typically make use of forensic accountants, including: 

Insurance

The insurance industry is one of the most common employers of forensic accountants. When a client makes a claim, be it for an automobile accident, medical malpractice, negligence, or something else, the forensic accountant’s job is to quantify the resulting financial damages.

Police

Some police departments employ forensic accountants dedicated to criminal matters. These accountants investigate claims of criminal fraud and serve as expert witnesses in criminal court.

Governmental Agencies

The FBI employs forensic accountants to investigate federal financial crimes such as check fraud, credit card fraud, mortgage fraud, bank fraud, and more. The Securities and Exchange Commission (SEC) employs forensic accountants to investigate market manipulation and insider trading. In addition, the Treasury Department employs forensic accountants through the IRS to crack down on tax evaders.

Public Accounting Firms

Public accounting firms employ forensic accountants for use in litigation, typically divorce or non-business-related matters. During divorce proceedings, these accountants seek to find hidden assets or financial breaches of contract. In other contexts, public forensic accountants may seek to quantify damages in civil court.

Notable Forensic Accounting Cases

Bernie Madoff’s Ponzi Scheme

As the 2008 financial crisis raged, many Americans were reeling from the blow. However, Bernie Madoff was not; the rogue financier had been defrauding investors out of more than $10 billion over the past 17 years. Unbeknownst to Madoff at the time, however, forensic accountants were putting the finishing touches on an irrefutable mountain of evidence against him.

Using masterfully-fabricated claims, Madoff attracted thousands of investors to his scheme. Then, in a Ponzi-style fashion, Madoff used capital from new investors to pay off old investors seeking to cash out. As long as Madoff could find new investors, his scheme could continue. However, when the markets crashed, his scheme crashed with it. Forensic accountants had all the evidence they needed for a conviction. For decades, Madoff made off with an eye-watering sum of money — and he was handed an eye-watering sentence to go along with it. Courts ordered Madoff to serve 150 years in prison and forfeit over $170 billion in assets.

Al Capone’s Taxes

In the 1920s, the FBI spent years trying to take down notorious mobster Al Capone. Known for running illicit businesses such as speakeasies, distilleries, and gambling rings, he meticulously covered his tracks, making conviction nearly impossible in a court of law. Due to his diligence, he was able to freely operate his criminal empire. However, forensic accounting ended up being the mobster’s undoing; over two years, IRS accountants collected evidence that Capone wasn’t paying taxes on his illicit income and spending dirty money. After collecting enough irrefutable evidence, Capone was tried and imprisoned for tax evasion, shattering his racketeering network.

The Enron Scandal

Since the ’80s, energy company Enron had been committing fraud; the C-suite worked together with the accounting team to stash millions of dollars in debt from sight. However, this web of lies came undone in 2001 when Enron’s share price collapsed from $90 to just $1 in just a year. Sensing suspicious activities, the SEC decided to open an investigation. SEC forensic accountants pored over Enron’s financial statements, bringing the corporation’s “creative” accounting techniques to light — hiding debt in partnerships, intentional misinterpretations of financial records, and stock inflation, to name a few. After conducting a criminal investigation, the court convicted Enron CEO and COO Jeff Skilling on several felony fraud charges and sentenced him to 24 years in prison, although this was later reduced to 14 years. In addition, former Enron CEO Kenneth Lay was convicted of ten counts of securities fraud, although the judge vacated Lay’s convictions upon his death.

Related Reading: Bookkeeping vs. Accounting

How Forensic Accounting Can Save Your Small Business

While the notable cases mentioned above entail unthinkable sums of money, the reality is that most fraud cases happen on a smaller scale. Unfortunately, with median losses of  $125,000, it is still enough to cripple a small business. If you find yourself falling victim to payroll fraud, benefits fraud, or any other type of business fraud, hiring forensic accountants to track down and recoup fraud damages is essential.

To prevent fraud from happening in the first place, however, you must take a proactive approach to your accounting. Hiring experts to manage your small business bookkeeping services, such as the professionals at FinancePal, is crucial for having clear, concise, comprehensive, and correct financial statements that can protect your business — and your assets — from fraud.

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What is GAAP?

Ubiquitous in the worlds of business and finance, GAAP is an acronym for Generally Accepted Accounting Principles. GAAP refers to a common set of accounting standards, principles, and procedures issued by the Financial Accounting Standards Board (FASB). An external audit usually determines GAAP compliance.

GAAP is sometimes qualified as the U.S. Generally Accepted Accounting Principles in international dealings since it sees primary use within the United States. While businesses with under $5 million in yearly revenue are not required to follow GAAP, many do. However, those that do bring in $5 million or more per year must follow the GAAP guidelines to avoid possible fees, fines, and even criminal charges. 

Regardless of revenue, the Securities and Exchange Commission (SEC) mandates that all publicly-traded companies adhere to GAAP. While not required by law for non-publicly traded companies bringing in less than $5 million annually, GAAP compliance is still critical for cultivating a favorable perception from creditors and lenders. Most banks and financial institutions require GAAP-compliant financial statements when issuing business loans.

The 10 Principles of GAAP

GAAP is comprised of ten core tenets or principles. While GAAP may apply differently depending on whether a business uses cash vs. accrual accounting, the general principles remain the same. These principles are: 

1. The Principle of Regularity: The adherence to GAAP rules and regulations as a standard.
2. The Principle of Consistency: The application of the same standards throughout the reporting process to ensure financial comparability between periods.
3. The Principle of Sincerity: The provision of an accurate and impartial depiction of a company’s financial situation.
4. The Principle of Permanence of Methods: The commitment to using procedures used that are consistent, allowing comparison of the company’s financial information.
5. The Principle of Non-Compensation: The reporting of both positives and negatives with complete transparency and without the expectation of debt compensation.
6. The Principle of Prudence: The commitment to using fact-based financial data representation without speculation.
7. The Principle of Continuity: The commitment to operating a business while simultaneously valuing assets.
8. The Principle of Periodicity: The reporting of revenue during the appropriate accounting period.
9. The Principle of Materiality: The commitment to fully disclose all financial data and accounting information in financial reports.
10. The Principle of Uberrimae Fidei (utmost good faith): The commitment to honesty in all transactions.

What is IFRS?

IFRS, which stands for International Financial Reporting Standards, are principle-based reporting guidelines primarily utilized outside of the United States — in fact, more than 144 nations have committed to using IFRS. The IFRS are administered by the IASB or International Accounting Standards Board. 

With business dealings being notoriously opaque in the past, IFRS was explicitly designed to prioritize transparency for the sake of lenders and investors alike. The IFRS contains detailed instructions for record-keeping and financial reporting alongside guidelines for universal accounting practices.

What Does IFRA Require?

IFRS contains guidelines for creating five mandatory financial statements:

1. Statement of Financial Position: This document is equivalent to the balance sheet.
2. Statement of Cash Flows: This statement outlines financial transactions conducted during a specific period broken into three categories: operations, investing, and financing.
3. Statement of Comprehensive Income: Similar to a profit and loss statement, but this document also includes non-direct income.
4. Statement of Changes in Equity: Essential for investors, this statement details a business’s change in earnings during a specific period. Often, the statement of changes in equity is referred to as a statement of retained earnings.
5. Accounting Policy Report: While not a financial statement, this report details a business’s accounting approach to safeguard against strategically opaque accounting practices. 

Related Reading: Accounts Receivable

What is the Difference Between GAAP and IFRS?

As previously mentioned, the most notable difference between the two standards is their scope; while GAAP is primarily prevalent only in the United States, IFRS is used worldwide. This may change in the future — the SEC has been coaxing an American shift to the IFRS for some time now — but many American businesses do not see this transition as a priority. 

Another significant difference is that while GAAP seeks to enforce rules, IFRS is guided by principles. This becomes apparent in each standard’s language — while GAAP is rather particular, IFRS provides a more general overview of its tenets. As a result, IFRS does allow some room for interpretation. However, many experts consider IFRS to be more effective and representative of applicable business reporting, likely due to its inherent logic. 

Another primary difference is IFRS’s treatment of “intangible assets” — assets that, while not physical in nature, help a business’s bottom line. Common examples of intangible assets are concepts like brand recognition, brand goodwill, and intellectual property. Whereas GAAP does not provide guidelines for reporting intangible assets, IFRS very much does. 

Related Reading: eCommerce Accounting 

When running a small business, a highly competent financial team can provide essential business insights, find crucial tax savings, and allow business owners to spend less time stressing the financials and more time serving customers. Sign up to get a custom quote today for FinancePal’s professional financial services.

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