Avoiding Over-extension of Finance and Resources

Many sound businesses have failed not due to their operations or their product offering, but simply due to the mismanagement of their finances.

Over-extension means that a firm has taken upon too much debt to finance its activities. A common failing of businesses is under-capitalisation. This is where an owner does not contribute enough start-up capital to fund the establishment of the business. In this case, to continue operations, the owner is required to take on debt leading to over-extension.

The business could turn out to be a success, but due to pressure of interest payments and the unwillingness of banks to continue to provide external finance (debts), the business can fail and be forced into administration or liquidation.

As a business grows, the sources of finance should be balanced between internal sources (equity and retained profit) and external (debt) - see Balance Sheet.

Similarly, a business should avoid over-extending on inventory. Many businesses fail early due to an over commitment to the purchase of stock - that might not be desired by the consumer, go out of date or become obsolescent. This crimps cash flow and can result in early business failure.