5 Alarmingly Common Reasons Stable Businesses Become Insolvent
Whether your business is growing month after month or continuing to generate a stable amount of profit, poor habits and cash management can often cause it to go from stable and successful to insolvent in very little time.
Businesses become insolvent for a wide range of reasons. Some businesses face a cash flow crisis caused by customer non-payment, while others simply fail due to changes in market conditions or increased competition from other businesses.
Even if your business is doing well, it’s important to understand that insolvency is always a possibility, and that taking steps to protect your business against it is an excellent idea.
As the old idiom states, it’s best to “hope for the best, and prepare for the worst.” By familiarising yourself with the most common causes for business insolvency, you’ll be better able to protect your business from falling victim to them.
In this post, we’ll examine five of the most common reasons stable, successful and profitable businesses become insolvent and how you can ensure your business is protected against them.
Cash flow crisis caused by limited funds
When your business earns tens or hundreds of thousands of pounds in profit every month, it’s easy to assume that you can take a large amount of money out from the business without affecting its stability.
After all, next month’s earnings will be enough to cover any unforeseen expenses or surprising bills, right? Not so. Sales can vary from one month to the next, and a small downturn could be all it takes to wipe you out if you don’t have ample cash reserves.
Even if your business is doing extremely well and generating large profits, it’s vital that you keep enough cash in your company’s bank account to cover expenses such as payroll, inventory, production, rent, taxes and other essential costs.
Cash flow crises can occur on a moment’s notice, especially if you haven’t kept track of your company’s expenses. A tax bill from HMRC for unpaid VAT could be all that’s required to knock your successful, stable business off the financial rails.
The best way to avoid a cash flow crisis is to be prepared for any financial issue that could affect your business. Keep enough cash in your company’s account to cover its expenses and liabilities, even if doing so means slowing down its growth rate.
Loss of business from new competition
Have new competitors recently entered your industry? Competition isn’t necessarily a bad thing for your business. In many cases, competitors validate that your market is worth operating in and help you make your business better.
However, ignoring your competitors, especially when they’re growing rapidly, could lead to your business losing market share. This, in turn, can lead to declining profits and a lack of cash to operate your business effectively.
The best way to avoid losing market share to a competitor is by preparing ahead of time. Study your competitors and understand their value proposition and benefits, then make sure your business offers better quality (or better value) than them.
It’s also worth focusing on customer retention. Since your competitors will need to start from scratch, building a “moat” around your business by retaining customers will help you keep your revenue stable even if competition increases.
Loss or failure of an important customer
Is your business overly dependent on a single customer or client? If your business generates a large percentage of its profits from a single customer, it faces a serious risk of failure if the customer decides to switch to a competitor.
Likewise, the failure of an important customer or client – for example, a business bankruptcy for a B2B services client – could result in your company not receiving payment for its products or services.
This can be financially devastating, especially when your company offers a line of credit to its customers. Thankfully, the negative effects of losing a large customer can be mitigated by diversifying your business’s sources of income.
Focus on acquiring new customers and clients that contribute a larger amount of income than the one large customer your business currently depends on. This will give you alternative sources of income in the event that a large customer fails.
Excessive debts and lack of stable sales
Have you borrowed heavily to build your business? Lots of businesses, from retail stores and restaurants to technology companies, depend on loans in order to build their product, rent retail property and start operating.
When your business is performing well, paying back debts and dealing with the cost of property rental is easy to manage. However, a single month of poor sales is often all it takes to cause your debt-related costs to exceed your monthly income.
Borrowing excessively places your business in a risky position – a single period of low sales can lead to its failure. Prepare ahead of time by keeping cash within your business to make up for temporary downturns in sales and revenue.
It’s also important to minimise the amount of unnecessary debt your business takes on, especially in its early stages. Excessive debt creates vulnerabilities that can place your business in an insolvent position if its cash flow comes to a standstill.
Poor retention of important employees
Just like losing an important customer can lead to the failure of your business, losing an important employee can also lead to its decline. If your business is dependent on one or two key staff members, it’s vulnerable in the event that it loses them.
Great businesses value key employees for their skills, knowledge and ability to help fuel growth and development. However, they never depend on individual members of staff, as this creates the risk of failure if multiple staff members leave at once.
Protect your business against the loss of key staff through preventative action. Look at the market salaries for staff members in important positions and ensure that your business is paying its key staff members what they’re worth.
It’s also important to pre-emptively mitigate the effects of losing a key staff member by ensuring your business isn’t overly dependent on one person. Ensure that other members of staff are trained to take over in the event of a sudden departure.
While it’s impossible to guarantee that an important staff member will stay with you for the long term, offering great compensation and ensuring they’re happy with the role they occupy in your business will help your business maximise its retention.
Is your business at risk of becoming insolvent?
For many business owners and company directors, the idea of becoming insolvent is completely unthinkable. When you have steady revenue and strong profits, it seems impossible that your company could one day face a serious cash flow crisis.
However, many of the world’s most profitable and successful businesses have faced cash flow issues and in some cases insolvency and bankruptcy with very little notice due to the loss of a key client or poor cash management.
If any of the above problems sound familiar to your business, it’s important that you take action now to ensure they don’t develop further. Preventative action is the best way to limit the risk of insolvency and ensure your business has a healthy future.