A business that is confident of its stable monthly profit and market share in its industry may never have given much thought on the idea of company insolvency.
But there are subtle warning signs that could catch any company off guard – and ignoring them could lead to catastrophic consequences for all stakeholders involved.
If detected early, there is still opportunity to circumvent these eight alarmingly common reasons leading to a company’s winding up.
Insufficient cash on reserve or contingency budget
A company should have sufficient cash on account to ensure unimpeded continuity of vital business operations in the event of unforeseen predicaments such as loss of a big client or when new competition emerges in the industry.
One common reason why companies go through insolvency is heavy expenditures on employee compensation and benefits as well as hard assets, investments, or technology without careful management of its cash on reserve.
While these are all integral to the growth and success of business, it is unsafe to assume that there won’t be financial problems along the way that could hurt the company.
Even if one profitable financial year comes after another, it is wise to have sufficient contingency budget that will keep the company afloat in the event of unexpected cash flow crisis.
Risky business strategies or speculative investment propositions
It is not a rare occurrence for companies, big or small, to take risks in business – more often than not, because of the enticing significant return of investment in a short period of time.
However, risky business strategies such as using shares as collateral or putting up physical assets to secure a loan can only lead to a desirable outcome if the market moves in the right direction.
When the speculative investment moves in the wrong direction, it can mean potentially massive income losses and can force the company to wind down.
If the company financial stability is heavily dependent on volatile opportunities or largely affected by market conditions, you should seek for alternative long-term business models to protect the company from the threat of insolvency.
Too much focus on a particular customer
Inking the deal with an important customer can be a huge confidence booster for the company, especially if the contract assures regular, continuous, long-term revenue flow to your business.
However, putting too much reliance on a single source of income can also increase the risk of facing insolvency. How?
- If customer demands entail necessary expansion/expenditures on your part (e.g. hiring additional employees, purchase of new equipment, upgrade of technology/software, etc.)
- If customer has suffered unforeseen business losses
- If customer relationship with your company goes bad (in which dissolution of contract is the only logical move afterwards)
These would lead to decreased or loss of expected profits for your business and retaining the expenses that come with the contract.
It is therefore worth to consider acquiring new customers to diversify your income-generating accounts and to steer clear the company from the issue of insolvency.
Overdependence on a key organisational staff
Just like too much concentration on a particular customer can be a factor for company insolvency, putting too much faith on key organisational staff can bring your business down the drain – in the event of employee departure.
While highly competent workers are crucial for growth and success of the business, there are many staff-related risks that can easily lead the company towards liquidation such as:
- Talent poaching by competitors
- Sick leave or hospitalisation leave for health reasons
- Termination or dismissal due to legal issues or contract violations
- Sudden career change
A healthy and effective business is one that is not overly dependent on one or two individuals even if they can no longer be part of the company.
Rapid business growth
Increased demand for products or services from your existing consumers and new clientele base is great for business but only if you can keep up with its corresponding capital investment or operational costs.
Newly incorporated companies and SMEs, in particular, can find it difficult to manage especially if they have not yet fully recovered from the cash outlay to start the business.
But there is nothing to worry about if your business operations can survive on credit, if your monthly revenues are bigger than your monthly expenses, or if your receivables are on track.
However, having less-than-anticipated cash flow, delayed collection of receivables, and struggling to reach the break-even point can quickly turn a seemingly minor hiccup into an insurmountable obstacle.
If striking off the company is something you don’t want to see on the horizon, put in position sensible safeguarding measures to keep the cash flowing on a regular and consistent manner – whether through getting a pre-approved credit line or having sufficient contingency budget to alternative finance, as well as diversifying your investors, client base, and key organisational staff.
When a company is facing challenging financial conditions, one of the quickest ways to maintain or improve short-term cash flow is by rescheduling staff remunerations, putting a director’s pay freeze, delaying tax obligations, and rearranging credit payments.
However, having this as a monthly or quarterly occurrence could be a sign of deep-rooted company problems that could lead to any of the following:
- Negative impact on company credit score
- Pressure from mortgage lenders
- Petition for compulsory liquidation from creditors
- Tax penalties or other legal consequences
If the last thing you want to do is seek professional advice from a private liquidator, combine a solid business plan with efficient organisational management and a fool-proof financial strategy that would avoid late payments.
Underestimating the competition
New players in the industry aren’t necessarily a bad thing for your business. In fact, the emergence of competition only validates that your particular market is worth operating in.
However, it is unwise not to anticipate how your competitors operate or worse, not to respond accordingly when they are growing more rapidly than you expect because this can quickly snowball into irreparable business problems.
To avoid considerable loss on your market share due to new competitors, you have to have a clear perspective of their unique selling proposition (USP) to your target clientele base and then come up with a product or service offering that offer better value and quality. Furthermore, your focus should be on customer retention especially when you have the advantage of being a more seasoned player in the industry.
Lingering and unsolved problems
The ability to stay on top of all business operations can be quite an overwhelming one-man-show for both the fledgling director and seasoned business manager alike.
When financial records are in disarray, when customers are switching brands, when employees are unhappy, or when creditors are issuing a litigation threat – and any or all of these have been going on for a while – it may give rise to a statutory presumption that the company is on the verge of failure.
If the road to company insolvency is something you don’t want to take, the best thing to do delegate administrative tasks to professionals or skilled outsourced providers.
For many business owners and company directors, the idea of seeking professional advice from a licensed insolvency practitioner is completely unthinkable. But no matter how improbable, the abovementioned reasons can prove otherwise.