Warning signs of potential business failure

Hindsight is a wonderful thing…

As insolvency practitioners, we are often asked for the top reasons businesses fail.

The first point we want to make is that hindsight is a wonderful thing. When reflecting on events leading to the failure of a business it’s easy to be self-critical. The truth is, business owners are human beings who attempt to make decisions based on historic and current information, to meet a future need or opportunity. Therein lies the problem! Just like weather forecasting, we can have all the experience and data in the world, but we can still get it wrong, and sometimes spectacularly!

Below is a summary of some of the more common causes of business failure that we have seen.

Insufficient or poor information

To make good decisions, you need access to relevant and up-to-date information.

Information can be both financial and non-financial and from both inside and outside of a business. Examples include management accounts, market data, customer surveys, competition reviews, etc.

The key is to ensure that the information is up to date, as accurate as possible, suitable for the decision at hand and presented in a way that is meaningful to the decision-maker.

All this will lead to the best possible decisions being made.

Lack of working capital

Insufficient funding to meet ambition is an extremely common problem. The greatest idea, supported by the most robust of plans, cannot be implemented without the necessary funding. All too often we see businesses fail because they take on an opportunity that they are unable to fund to completion.

Late payment and bad debts

Many businesses operate with an insolvent balance sheet (i.e. their liabilities exceed their assets), so a significant delay in payment from a customer, or worse still non-payment, can have a catastrophic effect on cash flow.

If a business is slow at collecting payment on invoices or is exposed to a particularly large client, immediate action needs to be taken to mitigate that risk.

Cash flow management

All of the above feeds into good cash flow management. Many businesses operate with an insolvent balance sheet (by that we mean that the value of its liabilities exceeds its assets). This is acceptable as long as, on a cash-flow basis, they can meet their financial obligations as they fall due.

If an entrepreneur does not take the time to understand and plan their business cash flow, then this is cause for concern.

Industry changes and product innovation

We have all seen whole industry sectors come and go, either through innovation, or migration to other parts of the globe where they enjoy better trading conditions.

For example, once there was a video rental business on every high street, but now they are gone, replaced by video streaming services such as Netflix and Now TV. The pace of change is fast, unstoppable and sometimes unpredictable.

Change is also driven by developments in law or government policy. Examples include the smoking ban and both the introduction and recent withdrawal of government incentives for renewable energy.

Business owners must take the time to consider the world around them and be prepared to change course when required. This has never been more important than it is today with the ongoing Covid-19 crisis.

Misreading the economic cycle

Timing is everything, and creating a business not suited to the current and near term economic climate leaves it exposed to failure.

The construction sector was hit hard by the onset of the recession in 2008. Notwithstanding the lack of supply of homes in the UK, the sector relied heavily on bank funding for development, whilst consumers relied on the banks to provide the necessary mortgages to buy. When the banking sector became unable to support both, the whole industry suffered a significant decline.

Loss of key staff/Ill health

Businesses rely on great people. When they are lost, the impact can be significant, especially in smaller businesses that employ fewer people.

Other common contributors to failure include:

•           Inefficiency;

•           Increased local competition;

•           Poor customer service;

•           Lack of clear vision/strategy;

•           Poor leadership;

•           Disputes;

•           Poor pricing.

In summary

When an entrepreneur leading a business identifies a problem, they should not delay in tackling it head-on or be afraid to seek early advice and support. The sooner they seek advice, the more options will be available for them.

We would like to leave you with one last thought:

“A man must be big enough to admit his mistakes, smart enough to profit from them, and strong enough to correct them.”

The above was quoted by John C Maxwell, an American author and speaker who focuses on leadership and speaks annually to Fortune 500 companies, government leaders and diverse organisations.