David Gilbert identifies five common reasons for corporate failure, ranging from elementary lack of basic controls to an ostrich-like failure to face facts. How many of them apply to your company?
When the economy is benign, and when your company is doing well, do you really need to read this depressing article? You know you do! If the economy takes a downturn, it could seriously affect the viability of your business. Learning from other companies' misfortunes can avoid experiencing them firsthand. You need to avoid the five core factors in business failure:
1. Inadequate records
Management needs proper books and records. Without a real understanding of the business's profitability and cashflow, there is no way that management can have its finger on the corporate pulse. As a direct result, there is little insight on how day-today decisions can affect the business.
2. Failing to forecast
Management often argues that it's impossible to predict the future, and that cashflow and profit forecasts are not worth the paper they are written on. This may be the case initially, but if forecasts are refined on a regular basis as actual results become available, they will have meaning. The application of sensitivity analysis gives management an insight into the areas where the business is underperforming. As a consequence, management can address the cause of material adverse variances while there's still time to do something about them, and before major damage is done to the business.
3. Devoting capital to pet projects
I have seen, on numerous occasions, the chief executive and power brokers of a company pressurising the board to invest in new ventures where the company may have little or no expertise and insufficient working capital to afford a failure.
Subsidiary companies are often set up specifically as vehicles for new ventures. If they fail, they can easily bring down their parent company. Over the years, amounts due to parent companies from subsidiaries which cannot afford to repay their debts can easily run into many millions of pounds. If less senior management had the confidence to speak out loudly enough and early enough, before rash decisions are imposed from above, they would bring balance to the management team and corporate failure could be avoided.
This is a cultural issue: while many successful companies are run by autocrats, virtually all the failures I have seen over the past 25 years have involved dysfunctional management teams. These can be characterised by the following: * there is no stated team objective
A more balanced management team will inspire far more confidence with its shareholders, bankers and creditors if the going gets tough.
4. Lack of courage to take action
Rationalisation of a business can return a company to profitability. A sale of part of the business, or refinancing of the business in its entirety, can repair working capital.
Unfortunately, some management teams go into self-denial in times of adversity and do absolutely nothing. By the time they are forced to face reality by their bankers or creditors, it is often too late.
In a financially troubled situation, far too few management teams recognise the need for one of their number to take on a turnaround role, and the potential benefits that can arise out of such steps.
5. Weak controls and systems
Companies often fail to maintain proper financial controls and systems, particularly as a business grows. Over-trading is a common cause of failure. Take the example of one company that recently consulted me - a factoring company that was concerned about one of its clients.
The client, a manpower company, had seen its business grow from an £8m annual turnover to f ism within one year. The company's board consisted entirely of salesmen. Even while the company was operating at an £8m turnover level, one financial controller and two credit controllers could not cope.
When turnover hit the £15111 level, the credit control function was overwhelmed by the company's growth, and could not cope with the volume of queries from debtors. This led to a large proportion of the company's debtor book going over 90 days, causing the factoring company serious concern.
The financial controller was also overwhelmed and, as a result, no-one within the company had any appreciation of the working capital requirements. If the financial controller had had the time to prepare cashflow and profit forecasts, the board would have realised that, in order to fund the current growth, the company required far in excess of the f 2m facility made available by its factors. Subsequently, due to over-trading and problems with credit control, the company had become insolvent as it could not pay its creditors as and when debts became due.
What was the solution? Working as a team with management and the factoring company, we were able to ensure short-term financial support with both the factors and the company's bank. During this period, the company has recruited an additional two credit controllers and has dramatically driven down disapproved debtors. It also recruited a part-time financial director, who has not only rationalised the business but, more importantly, has instilled a respect for all financial aspects of the business among the sales-driven board of directors, who now fully appreciate the near miss the business experienced.
In addition, a strategic plan geared towards controlled growth has been prepared, demonstrating that a company can achieve a healthy profit while operating within its working capital constraints.
Communication is vital
These are the five core reasons for failure. I also believe that if directors of financially troubled companies had the benefit of hindsight, they would ensure that they enjoyed open and honest communication with fellow directors, bankers and shareholders.
By being able to talk openly with fellow directors, the management team can remedy weaknesses, if need be, by change. In many instances, failure to communicate properly with bankers breeds nervousness and distrust. Companies which provide their bankers with regular and meaningful financial information so that bad news does not come as a major surprise, are more likely to enlist the support of their bank to help resolve problems.
On numerous occasions, a failure to communicate with shareholders leads to shareholders feeling their investment is not being properly nurtured.
Many companies which fail, fall helplessly into the abyss. Problems which could have been identified at a very early stage are left unattended because of the misguided management belief that the seriousness of the situation is not worth worrying about and that things will get better unaided.
Stronger management teams with a strategic business plan that meets the expectations of bankers and shareholders, and which have the ability to use a contingency plan if the going gets tough, will ultimately be the survivors in today's market.
New insolvency regime
Earlier this year, Stephen Byers, UK Secretary of State for Trade and Industry, announced a new insolvency regime which is expected to give 500 firms a year the breathing space to put in place a rescue plan, as well as speeding up the current process for disqualifying unfit directors.
The new Insolvency Bill will introduce a moratorium for firms in financial trouble using Company Voluntary Arrangements (CVAs). This will allow managers some time to put a rescue plan to creditors without fear of legal action.
The Bill also includes a fast-track system where, if the director agrees, disqualification can be done administratively rather than through the courts. Some 1,500 unfit directors were disqualified last year after a company failure and, with only 10% of cases contested and going to a full court hearing, Stephen Byers sees "a great deal of scope to reduce the burden on the courts, free up more of their time to deal with other issues and to save costs."
The government has decided not to proceed with an initial proposal to require floating charge-holders to give a period of notice before the appointment of an administrative receiver.
Publication of the Insolvency Bill coincided with release of insolvency statistics. These showed that there were 3,450 company insolvencies in the final quarter of 1999, while the total number of company insolvencies in England and Wales for 1999 was 14,280.
