It is interesting to note that the causes of Company failures, as reported to us by Directors, are many and varied, but are often not always correctly unidentified by the Directors of the failed Companies.
There are, however, some common themes, and some of these include:
1. Over-reliance on one customer
It is not uncommon in Insolvencies to find that the failure of the Company has come about because it has over-relied on one large customer. The sudden failure of this customer, or the decision by that customer to go elsewhere, has decimated the Company's turnover and profitability.
Directors do not always have the marketing skills to get out and promote their business, nor the financial understanding to see ways to restructure their Company; to take into account the sudden loss of a major customer, and to bring about recovery of the Company.
2. Economic downturn
A sudden and unforeseen downturn can sometimes lead to the Company cutting its prices in an endeavour to retain customers and obtain new work. Often this is done with no thought as to what it actually 'costs' to do the work.
It can be that the prices are reduced so much that there is no margin, and in fact the hole is dug deeper; instead of creating further cash and profit to fix the hole created previously.
3. Lack of administration and accounting skills
Often Companies are created because someone is 'good' at doing what they do. The tradesperson, or somebody with a passion for retail, thinks that it is a good idea, and that they would be better off working for themselves than working for someone else.
While they are very capable plumbers, builders, electricians, etc, they have never been involved in running a Company and managing the financial challenges before.
They often start with a few tools and a vehicle, no working capital, and no administrative systems in place. Many do not keep accurate records, fail to keep good financial information, never review operating performance, and simply exist from day-to-day.
Often we see that when there is money in the bank account, it is spent on personal items, such as a new car or a holiday; without giving any thought to things like GST, PAYE, and the ever looming tax debt.
What generally follows is a failure to pay the debts as they become due, and often the Inland Revenue Department becomes the largest creditor.
The cumulative effect of these failings is a downward spiral, until such time as the bank refuses to extend the overdraft, and a major creditor, most likely the Inland Revenue Department, threatens to wind them up unless the debts are paid.
4. Red flags that indicate all is not well
i. Failure to pay GST and PAYE on time, or at all. PAYE is the worst tax to be in arrears, as this is money held on trust, deducted from employees' wages, and should not be available for business operational purposes. This is not the Company's money!
ii. A steady increase in outstanding creditors, and increased age of the creditor debts. For example the 90 days + creditors amount is ever increasing.
iii. There is always a need for the Shareholders to put money into the Company to pay the Company day-to-day debts.
iv. GST refunds, perhaps two or three in a row. This means the Company is consistently spending more than it earns, as there is no GST on one of the biggest expenses, which is wages.
v. Insistence by creditors for 'cash on delivery' meaning the account is outside normal terms of trade.
How CS Insolvency can help!
A lot of the causes of Company failures come back to the fact that there needs to be good systems in place, and good financial information available on a timely basis. Business owners also need to seek, receive, and act on good advice.
What needs to occur is putting in place improved management and financial reporting systems.
a· Restructuring the current debt through negotiations with lenders, and compromises with creditors.
b· Identifying areas within the business where the Company may need to engage other outside expertise, such as marketing and legal advice.
c· Identifying the Company's 'point of difference', and why it exists in the first place.
d· Is the pricing appropriate? Are the mark up and margins at acceptable levels?
People do not create businesses to fail, but often new businesses fail to plan, fail to seek advice, and fail despite the best efforts of the Directors.