How to guard against business failure

Posted on October 12, 2012 by Lee Manning, R3 President

As the trade body for Insolvency Practitioners, our members work with businesses that are experiencing financial distress – R3 stands for ‘rescue, recovery, and renewal’ and that is exactly what our members aim to do.

Typically, when we refer to a business in distress, we mean one that:

  • Is experiencing decreased profits and mounting losses
  • Has seen a reduction in sales volumes
  • Has seen a fall in market share
  • Is regularly using its maximum overdraft facility
  • Is struggling to meet its financial obligations; or is having to make redundancies.

However, the unusually long length of this recession has meant that business distress is also manifesting itself in other ways – enter the ‘zombie businesses’. R3 has recently identified four signs that indicate that a business could be operating as a zombie:

  • Just paying interest on debts, but not reducing the capital
  • Struggling to pay debts when they fall due
  • Having to negotiate payment terms with creditors
  • Will be unable to pay debts in the event of a small rise in interest rates

Our research has shown that 8% of businesses in the UK are only paying the interest on their debts, this equates to 146,000 businesses. Today’s difficult economic climate shows no sign of abating and so it is important that businesses are not only aware of the tools they can use to help themselves, but also the solutions available to them, should they be in serious financial difficulty.

Of course the challenges for every business will vary, but there are certainly some general measures that any director can take to guard against failure.

1. Don’t max-out the business overdraft each month

Make sure you have sufficient capital reserves to take advantage of opportunities. Have either cash reserves or access to borrowing through your bank.

2. Produce a business plan with forecasts

A business plan gives strategic focus to the business. Ensure that actual performance is monitored against forecast. You need to keep a close watch on cash-flow, as this is the oxygen of a business.

3. Pay accounts on time, not on receipt of writ, and benefit from discounts

Late payment of bills sends out a clear sign to suppliers who may eventually grow weary of having to wait and may refuse to supply. Pay on time to take advantage of early payment discounts and create goodwill with your supplier. You may still need to call the favour in. If you are not able to pay, seek an extension from your supplier.

4. Impose strict credit control and debt collection procedures of your own. Guard against the domino effect

Only deal with customers who will pay their debts. Insolvency Practitioners estimate that 27% of corporate insolvencies are triggered by another company’s insolvency. Make sure there you have a broad customer and supplier base, as relying on a few customers could be crippling if they default on payments or fail. If your debtors are not paying on time, chase them up. By allowing them to owe you money you are financing their business.

5. Stay up-to-date with all Crown payments

If you have cash flow problems, ask for a ‘time to pay’ arrangement from HM Revenue & Customs. So far they have been sensitive to the needs of business in this recession. However this must be viewed as only a short term fix – money deducted from salaries and VAT does not belong to the business.

6. Don’t hold a large amount of stock in relation to turnover/profit

In the upturn the challenge is to have the stock to supply the needs of your customers promptly; this is when you will need to carry some stock. But see if you can arrange ‘just in time’ supplies with your key component suppliers as it will minimise stock carrying costs.

7. Is your accounting system fit for purpose?

Have a system which produces the information you want on a timely basis. Also, be on good terms with your bank manager, keep them informed of developments whether good or bad and provide management figures regularly.

8. Don’t put off seeking professional help

The sooner a business in difficulty seeks professional advice the greater their long-term chances of survival. Seek professional advice from a regulated professional or reputable trade organisation as soon as possible. Seeing an Insolvency Practitioner can give you the best chance of turning your business around and avoiding insolvency – they usually offer their first hour of advice free.

9. Don’t put significant personal assets at risk

Avoid committing significant personal assets to the business without taking independent advice first – your family’s welfare is more important than the business.

10. Review for under-utilised assets and unnecessary costs

Assets should be made to sweat and work for the business. Surplus assets should be sold to generate cash. Costs savings will also enhance cash-flow.