Major causes of small business insolvencies revealed
Acquisitions that go wrong are a top cause of business insolvency, according to Purbeck Personal Guarantee Insurance, which has analysed claims from business directors for personal guarantee insurance, following insolvency. Not being close to business financials due to an over-reliance on accountants, and bad debts or payment disputes, were also major reasons why business owner’s dreams ended in a nightmare. There is good news, however, as there are solid steps that can be taken to avoid some of the most common reasons businesses fall into insolvency.
Todd Davison, MD of Purbeck Personal Guarantee Insurance said: “Business failures can often occur after a business acquisition. When a business goes through a leveraged buyout, where the target company to be acquired is loaded with debt to buy out the former shareholders, then this has an adverse cash flow and margin impact to meet the repayment obligations. It means an immediate deterioration of the balance sheet position. So the new owners have to grow the business or deliver substantial cost savings through the business quickly, to avoid failure.”
Firms window dressing their business to make it appear more secure than it actually is prior to acquisition can be common, according to Purbeck Personal Guarantee Insurance. Robust due diligence processes including, arranging a financial audit, scrutinising the validity of future orders and analysing future staff and cost savings that can be made once acquisition has happened, can all help to sidestep insolvency.
Purbeck also advises keeping a close eye on the balance sheet. It found that often a director, who is incredibly skilled at providing a product or service, may rely on their accountant for day to day financial running of their business. Unfortunately though, it is the business owner who ultimately shoulders responsibility for business cash flow, so directors should seek clear explanation from accountants to ensure they are always knowledgeable about their financial situation.
Bad debts or payment disputes were the third most common reason businesses fell into insolvency. Businesses looking to protect themselves from bad debt will always research potential clients thoroughly before selling goods and services to them. According to Purbeck, however, a common theme amongst directors claiming on their Personal Guarantee Insurance was an overconcentration on one or more customers who were late payers, which in due course, put a stranglehold on the creditor’s business.
Finally, when a business is doing well, it is tempting to raise finance to develop it further, but when growth slows, firms often find the finance cost becomes unaffordable. Todd Davison concludes: “Instances like overtrading can be avoided by focussing on profitability, rather than revenue growth. Equally, due diligence before an acquisition and trying not to put all your eggs in one customer’s basket can all help to make positive impacts on trading. Ultimately, everyone wants small businesses to succeed, as a personal guarantee insurer, none more than us. With personal guarantee insurance in place, however, the comfort of knowing that directors will not have to pay back business debt through their own finances, such as their home or personal savings can be hugely reassuring to small business owners.”
