FINANCIAL ISSUES THAT CAN RESULT TO BUSINESS SUCCESS INCOMPETENCE

Lack of Cash and Cash Management

Generally the main trigger that causes failure is the lack of cash rather than the lack of profit. Business can hold out for a period whilst making losses – eventually however those providing credit (bank or creditor) will take action and withdraw or restrict credit. This problem is most significant in the current market where banks are reducing overdrafts and insurers are withdrawing debtor covers. A more immediate issue is where the business is unable to pay costs such as wages where no credit is available. Inefficient management of debtors, creditors and stock positions will absorb cash and give rise to an increase in a company’s borrowing requirement.

It is critical to manage cash flow on a day to day basis. Knowing exactly when cash is likely to come in and from whom – then balance that with a planned payment programme. Businesses that run out of cash or do not stick to payment plans lose goodwill very quickly. Understanding cash flows and managing customers and suppliers expectations is absolutely vital in this downturn.

 Lack of Equity

Very many new businesses are under capitalized and rely on debt or creditor credit to fund the business. Neither of these sources are risk takers and if the risk is judged to be too great, the facilities are withdrawn. Businesses need to source equity at the outset or as its circumstances change in order to ensure continuity and that reasonable risk can be taken in developing or continuing the business. It is not recommended that equity is replaced by personally securing debt – equity and debt should be kept apart.

Be sure to utilize the correct type of debt, in times of growth Invoice Discounting can be the perfect method, however when falling sales are falling Invoice Discounting sucks cash out of the business. Match repayments on a term loan or equity payment plan to annual seasonality and long term business planning.

Inappropriate Financial Management

Inappropriate financial management is a common cause of failure and is usually evidenced by excessive levels of debt relative to a borrower’s cash generating capacity, the cyclicality of the industry within which it operates and the flexibility inherent within its cost structure in the event of an unforeseen downturn. Insufficient gearing may also be deemed to be inappropriate financial management in certain circumstances. Whereas a highly aggressive financial policy can lead to the development of a rapid crisis situation, an overly conservative financial policy may result in insufficient investment in the business and cause a prolonged period of decline leading, ultimately, to the failure of the company. An unsuitable structure for the company’s debt in terms of its maturity or currency profile, for example, also evidences inappropriate financial management as does an inefficient or non-existent risk hedging strategy.

  Inappropriate Capital Expenditure

Capital Expenditure should not be avoided, but a critical analysis of “pay-back” period should be undertaken. The expenditure producing the quickest pay-back is usually best in the current environment…. "Cash is king".

Companies are driven to undertake major capital expenditure projects as they strive to achieve organic revenue growth. Big projects go wrong because costs are underestimated or revenues are overestimated.

A feature over the last number of years has been for businesses to acquire their own premises. This was seen as the means of creating wealth, whereas the business itself was the producer of earnings. The equity needed to fund the premises purchase would have been extracted from cash flow / working capital. In the current market loan repayments are likely to be higher than rent payable. The double effect of reduced working capital availability and higher fixed costs is a major cause of business failure.

Lacks of Financial Control and Information

Lack of adequate financial control and, on occasions, creative accounting, is evident in companies in distress. In smaller companies, cashflow forecasting systems, costing systems and budgetary control systems might not exist. Similarly, key performance indicators, customer profitability and product profitability may not be monitored. In larger companies, the problem is more likely to be inadequate or overly complex systems rather than non-existent systems. Management needs relevant, timely and accurate information to assist it in the management of the business.

Reliance on Annual Audited Accounts is inadequate – an audit is produced at year end and is usually available six months after that year end. The statutory layout of audit accounts can be inadequate, particularly for manufacturing and service industries. Current information is essential in order to facilitate effective decision making. Treat your facts with imagination – but don’t imagine your facts. We recommend that business establish what the key variable drivers are (KPIs – Key Performance Indicators) and report quickly, at least monthly, on same (Flash Report). Sales, Gross Profit and Wages are usually key, whereas Rent, Rates and Insurance do not vary within the year. The Flash Report should be supplement quarterly with a full set of accounts and analysis. If decision are however critical, then Flash Reports will not be adequate, they are an indicator.  Banks are far more forensic today and require quarterly management accounts for most medium sized business.

Lack of Cost Control

All costs, whatever the state of the economy should be closely monitored and controlled. Cost cutting should be strategically viewed, be careful of cutting costs in areas that are critical e.g. sales. Take the hard decisions and cut in areas that are underperforming rather than the easy targets.

A company which has a substantially higher cost base than that of its major competitors is likely to be at a competitive disadvantage at all times.

Companies with higher cost bases will earn lower profits. As a result, these companies will generate less free cashflow and have less borrowing power. With less funds available to them than their competitors, they will not be able to invest as much on product development or marketing and they will not be able to commit to fixed capital investment to the same extent as their major competitors. They will be less capable of building and defending their market position. High costs also limit a company’s ability to compete in terms of price.