2 June 2014

Practitioner dissects the reason for last 10 business failures.

Operating a business over the last few years has been difficult with no industry immune to insolvency. So with all these failures, are there any lessons that we can learn?

To obtain an appreciation of these failures, I have reviewed the last ten administrators handled by my office to see if there were any common reasons for insolvency.

Summary of the jobs reviewed:

Industry	Business Age	Estimated Annual Turnover	Asset Deficiency	Director(s)’ reasons for insolvency
Construction	2 years	$900K	$600K	Failure of major debtor
Retail	5 years	$800K	$550K	Failure of Stockists Downturn in economy and trading losses Inadequate working capital
Transport	10 years	$11.7m	$2.9m	Trading losses Lack of accurate financial information. Downturn in economy
Construction	3 years	$1.1m	$340K	Trading losses Downturn in economy
Transport	5 years	$3m	$1m	Inadequate Working Capital Downturn in economy
Retail	8 years	$4m	$750K	Downturn in economy
Manufacturing	1 year	$600K	$1.7m	Director Disputes
Transport	6 months	$350K	$70K	Inadequate Working Capital Trading losses Downturn in economy
	4 years	$445K	$135K	Trading losses Downturn in economy
Mining Services
Agriculture	15 years	$1.5m	$600K	Inadequate Working Capital

This article will cover some of the common failings of the businesses.

1. Inadequate Records

If you take a moment to review the above table, you will observe that a “downturn in economy” was the most common reason for insolvency.

Obviously, the GFC and economic downturn hasn’t been a secret, so why didn’t the directors see the writing on the wall earlier and take preventative action?

After reviewing the records of some of these businesses, it would be a fair observation that their business records were so poor, they probably didn’t even know they had a problem. It is a wonder they were in business for so long.

But what do I mean by poor?

• No bank reconciliations
• No budget or business plan
• Financial statements, aged payables & receivables were incorrect or older than 12 months.
• No clue!!!

Some used the excuse that “it was the bookkeepers fault” or “I was too busy working in the business”. None appeared to take responsibility for their own business and making sure their records were accurate.

I remember interviewing one of the director who claimed he was “too busy working in the business” to keep the books up to date, but after speaking to his unpaid creditors, they indicated the director still had time to enjoy his jet ski every weekend.

Like everyone, I do not particularly like doing the books, but not giving them the attention they deserve, will fast track you to likely failure. The lesson here is; don’t make excuses and keep your records in order. If you don’t, you will soon have all the free time you want, when your business is gone.

2. No business plan

Of all the businesses I reviewed, none had a business plan.

Business plans are essential to ensuring you focus on your core business and plan for its growth. They do not have to be complicated as long as they cover some basic elements:

• Business: What is your business and where is it in the marketplace
• Marketing Plan: How are you going to market your business
• Operations: How does your business operate
• Employment: Staff, human resource policies and procedures
• Budget: Tracking your progress and monitoring working capital requirements
• Plan: What are your goals over the next two to three years

By actively monitoring these key areas, you can have your finger on the pulse and take appropriate action early to ensure the viability of your business is maintained.

Just reviewing financial statements that are 12 months old, is not enough. This information will be too old to assess the financial position and plan for the future.

Having a business plan can allow you to monitor working capital requirements and budget accordingly. This could potentially avoid the temptation to use other people’s money (i.e. GST, superannuation & PAYG) when you find you are unexpectedly short of cash.

Had some of the business monitored their financial situations more closely, they could have potentially avoided (or at least minimised) their business failures, by taking corrective action earlier. And not end in liquidation.

3. No budgets

None of the businesses reviewed had adequate budgets.

To quote our senior partner, Ivor Worrell, “Never start a new year, or a new business, without a realistic budget. If the expected outcome cannot be expressed in a budget it’s a gamble not a business.”

Over 40 years and thousands of insolvencies we have observed a close relationship between business failure and a refusal to budget. The start of the financial year is the ideal time to prepare meaningful budgets. Budgets assist in:

• Determining direction
• Forecasting outcomes
• Allocating resources
• Promoting forward thinking
• Turning strategic objectives into practical reality
• Establishing priorities
• Setting targets in numerical terms
• Providing direction and coordination
• Communicating objectives, opportunities and plans various managers.

All of these things are functions, which failed businesses have usually bypassed. Not all businesses with budgets prosper but most businesses without budgets fail!

What are the elements of a good business budget?

Worrells budgeting principles:

• Realistically reflects external and internal factors…it’s not wishful thinking
• Detailed and comprehensive – all aspects of the business incorporated
• Recognises seasonal fluctuations
• Consults with stakeholders
• Provides for cash flow forecasts
• Allows for ease of comparison to actual
• Reflects the enterprise’s policies and investment criteria

So get to it!!!

4. All your eggs in one basket

Being dependent upon one contract, product, or customer to operate your business is like playing Russian roulette with five bullets. This was the reason for failure in half the businesses I reviewed.

I have seen many successful businesses fail from being too dependent upon one source for work, which stopped and saw the businesses end up in my hands. Where possible, you should look at diversifying your products and customers or even consider insuring your debts. Always plan for the risk that the world will change and be ready to react accordingly.

Also, when that one contract comes along that looks too good to be true, seriously consider the risks if it goes bad. This was certainly the case for a construction company recently handled by my office. They accepted a large contract with a national company that required working capital of some $400,000. Although they appreciated the risk, they brushed this off on the basis they were dealing with a national company and focused solely on the profit side of the contract.

Unfortunately that national company was placed into liquidation and they lost their $400,000 and family home. The lesson to be learned here is, nothing is certain in this world. Giving credit or engaging in contracts that require substantial working capital investment is like playing roulette. The greater the profit, the greater the odds you will lose it all.

Never assume that because the party you are doing business with is a large corporation that they will always pay.

5. Knowing when it is time to call it quits

Calling it quits would have to be one of the hardest decisions a person has to make. Especially when so much of time, effort, and money is invested in the business.

I have interviewed a number of people that simply refuse to acknowledge their situation. Why? I believe what stops them from acknowledging their situation, was failing to appreciate the alternatives available. All they can envisage is a loss of income and how they would be perceived by their friends. It is the fear of the unknown that prevents them from taking action.

Generally, when you take the time to explain what life after insolvency or even a simple closure looks like, albeit not pleasant in some cases, removes that element of fear and allows people to assess their individual situation in a more critical fashion.

Spending some time with your clients to explore this option may allow them to better appreciate their situation and consider all the options available.

In summary, none of what I have outlined is rocket science and has been said in countless of our e-Update articles.

This is a simple reminder of the risks of doing business without the correct tools and maybe something you may want to send to your problem clients as a prompt for some action.

Remember Worrells is here to help.

Whether it is formally advice or an informal chat, we are always available to provide you and your clients with whatever assistance we can.