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Pitfalls in business and how to avoid them

John McQueen, chief executive of the Bankruptcy Association disuccess common causes of business failures Business focus series

In the majority of surveys undertaken on bankruptcy, undercapitalisation usually comes out as the main contributing factor. It can simply mean that a business has insufficient cash reserves to survive difficult periods of trading, or it can take the form of excessive borrowing. In simple terms, those running businesses should be aware of their ratio of debt to capital and try to keep this under strict control. In many cases where a business has failed it had borrowings up to the full value of the business or even higher. For capital intensive businesses, such as nursing homes and petrol stations, undercapitalisation in this form can be a severe problem. Many such businesses struggle to service huge borrowings and the interest payments inevitably overwhelm them. Cash flow Run out of cash and any business will quickly fail. What may look like a successful profit-making business on paper may be a business about to run out of cash because it has extended too much credit. In many cases businesses do not collect their debts fast enough to service their own creditors. One reason many give for this is the deliberate late payment by some companies. All too often, however, the real reason is a failure to implement strict credit controls within the business itself. Businesses should plan ahead for future cash flow requirements. They should arrange appropriate borrowing or make credit arrangements in advance of predicted needs. Rapid, unplanned expansion has brought about the downfall of many businesses. Lack of marketing No business can succeed unless it markets itself. There are no special formulas for success in selling, but neither are there any special obstacles. Businesses should ensure that gross profit margins are adequate to produce a net profit. This fundamental business reality has not quite got home to all entrepreneurs. A common mistake many businesses continue to make is to hold too much stock. Over-ordering or ordering to the wrong requirements compounds the problem. Stock ties up cash and should be kept to a minimum. Businesses should seek a range of prices from prospective suppliers before any order is placed. Poor budgeting and planning Every business must have a plan if it is to succeed. Long- and short-term plans should be made. These should be looked at daily and amended when necessary. Financial requirements should be assessed and budgets made to keep spending in line with planned requirements. Luck does have its place in business but it should not be relied on. At the heart of any businesses success is the ability of owners or managers to forecast future financial requirements and plan and budget for them. Non-payment by customers The risk of non-payment by some customers is, unfortunately, all too real. The importance of strict credit control procedures cannot be emphasised enough. Do not extend a lot of credit to unknown or new customers. Leasing agreements Leases can be taken on anything, but quite simply they can be legal bankrupting devices. The signing of leasing agreements has been a fatal decision for many thousands of people. Signing a leasing agreement can give security of tenure. Usually leases are taken for long periods of, say, 20 years. What many people fail to realise, however, is that in signing the document they have also given a guarantee to pay the landlord rent for 20 years. If possible, never sign a lease of any sort. If there is no alternative study the agreement carefully and work out the long-term consequences. Loss of financial backing Banks and creditors will have their reasons for withdrawing financial support. Often the real cause is overtrading. A business should never be allowed to grow faster than its ability to finance its increased activities. Any business should always have detailed financial plans available. Financial backers should be aware of these plans and the details should be discussed with them. It is also important to keep them informed of what is happening with the business on a regular basis. If the plans are changed, or do not run to schedule, then all of the financial backers should be informed. This will reduce the possibility of the sudden withdrawal of support. Destruction of a major asset Underinsurance can have catastrophic consequences. Insurance matters should not be neglected or overlooked and policies should also be properly maintained and managed. Cutting corners on business insurance to make short-term savings can be lethal in the long term. Personality Successful entrepreneurs all share certain personality traits. They have boundless energy, enthusiasm and optimism for the businesses they run, plus the ability to combine all of these traits with cool-headed pragmatism when faced with what are often difficult business decisions. Some people simply do not have what it takes and should stay out of the game.

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