Avoiding businesses failure
The vast majority of businesses fail because they run out of money. They reach a point where they are unable to pay their expenses, or pay staff, or meet their taxes, or repay their debts when those debts are due. If this condition continues someone eventually takes action to bring the business to an end, either via the appointment of an external administrator to the business or via a decision by the proprietors of the business to shut down.
In the vast majority of cases running out of money can be attributed to only 2 primary causes:
1) financial losses, resulting from either trading losses or major one-off events with a severe financial impact (for example, a catastrophic weather event), and/or
2) poor or ineffective management of the working capital of the business, resulting in cash being 'locked up' in debtors, stock or work-in-progress or cash being drained by creditor payments or capital spending. Even profitable can fail when working capital is poorly managed.
There are other causes of business failure, such as fraud, legislative changes or losing a licence to trade, but such events are rare.
Trading losses
Trading losses are the most common underlying cause of business failure. Most businesses can survive a short period of trading losses and some can survive an extended period of losses but sustained trading losses are an inevitable road to insolvency and business failure.
Macroeconomic uncertainties
The macroeconomic uncertainties, risks and threats facing your business in the future will be beyond your control. That does not mean that you cannot, or should not, plan your future strategies or forecast the future performance of your business. It is critical that you develop a plan for survival that will include financial forecasts.
The uncertainties of the foreseeable future dictate that there will be a range of potential outcomes for your business depending on how these factors play out. Uncertainty will dictate that you will be making assumptions based on imperfect information and your assumptions that may ultimately prove to be incorrect. To accommodate this future variability, your forecasts will need to be prepared based on a range of best, likely and worst-case assumptions. The accuracy of these forecasts will be determined by the quality of the assumptions that are used. It will be essential that you critically assess and evaluate the assumptions used in forecasting and regularly update and adapt them as circumstances unfold, to achieve the highest level of comfort possible in an uncertain world. You will need to exercise judgement based on your experience, your knowledge of your business and its customers, and your assessment of potential future events, in determining the most appropriate strategy for your business. The risk of error is increased as a result of the imperfections and uncertainties of your assumptions. Nevertheless, basing your decisions on imperfect information is far better than burying your head in the sand and hoping things will turn out alright.
Cash – the short-term imperative
In the short-term the survival of your business will be determined by how well you manage cash flow. Cash is the immediately critical element because it is essential to purchase production inputs, buy stock, pay wages, rent and the other expenses of the business. Cash is a finite resource that fluctuates on a daily basis in every business. The combination of the cash resources of your business and the rate at which that cash is dissipated and replenished will be the critical determinants of the capacity of your business to continue to trade in the short term.
In many cases, the accumulation of debts and deferred obligations to banks, landlords, tax authorities and other creditors means that your business may be coming out of the COVID with financial commitments exceeding incoming cash flow. You will be starting behind the cash flow eight ball, and this may remain the case even when trading reverts back to normal because trading cash flow will need to accommodate not only normal cash expenses but also the cost of servicing these historical liabilities.
Your cash flow forecast (you should prepare have a cash flow forecast at least 3 months ahead) needs to include these cash obligations. Where it becomes evident that cash generation from trading will be inadequate to meet current expenses and the obligations relating to the built up COVID debts, the payment arrangements for these historical liabilities need to be renegotiated. Resist the temptation to inflate your forecasts to cover these additional cash costs or to avoid these tough conversations. It is much better to be up-front and honest with creditors and seek a sustainable cash position rather than just hoping for the best.
Where your forecasts demonstrate a serious problem in meeting future cash commitments due to the burden of historical liabilities seek expert advice around restructuring or recapitalisation options, and do so sooner rather than later.
Profitability – the ongoing key to survival
While cash flow is the immediate imperative for your business, profitability will, in the medium and long term, be the determinant of business survival. Profitable trading is the sustainable source of cash flow regeneration for any business.
As vaccines are distributed and restrictions are eased, many businesses impacted by COVID are seeing some move back towards pre-COVID trading, although this trading is, in many cases, being disrupted again by the impacts of supply chain issues and staffing issues driven by the Omicron variant. Some commentators are predicting an early return to ‘normal’ trading levels. Every business manager must make their own call on the timing of a return to sustainable profitability but be aware of the risks when forecasting trading outcomes. For some businesses a surge in post-COVID sales is a reflection of pent-up demand that may not be sustained. For others, strong sales may be driven by the temporary lack of alternative spending options for consumers as well as unprecedented government stimulus.
You should consider these variables when forecasting future profitability. Remember also, that your competitors will be suffering similar impacts and this might lead to increased competitive pressures. On the other hand your competitors may be weakened as a result of COVID and this may present opportunities to you. You should seek to build as much flexibility as you can into your overhead structure as you rebuild or reinstate capacity.
Be aware of, and vigilant in monitoring, emerging risks of inflation and interest rate rises. Also be aware of, and prepared to respond to, supply chain risks, staff shortages (and staff wage demands driven by staff shortages) and the risks associated with any re-emergence of COVID lockdowns or trading constraints.
As with cash flow, where your forecasts demonstrate a lack of sustainable profitability seek expert advice around restructuring or recapitalisation options, and do so at the earliest opportunity.
If your business is in distress you may benefit from my book, ‘Survive in Business – How to Turn Your Struggling Business Around’, which can be purchased by following the link in the ‘Publications' page of this website.
If you have any comments or questions please email us via the Contact link on the website