UK: Warning: Danger Ahead? Business Failure

Last Updated: 7 January 2011
Article by Liam Dowdall

Is it possible to prevent business failure by looking out for the warning signs, and being more aware of the causes?

Warning signs

Some of the warning signs will be financial indicators. For example, falling turnover, gross margins and gross profit, and cashflow severely haemorrhaging as a result. Other warning signs include a decline in market share, problems with the products or services which may begin to suffer, or perhaps management leaving. Often when a business is in trouble good people will tend to leave while bad people will tend to stay.

As the problems evolve, there will be other, non-financial indicators. You normally observe very low morale in the business. There's no energy or enthusiasm – heads are down. From my experience with turnaround situations you get a good sense of what is going on from talking to people on the ground as much as to senior management, because they have a strong sense of what's going on. Businesses in difficulty tend not to have any clear strategies. Often they'll be like headless chickens, trying everything they can and panicking. People can simply put their heads in the sand to try escape the issues.

Often it's external people, such as the company's advisers or their bankers, who see what's going on before the company itself. Usually, at some stage either the bank or the company's financial advisers tell the company that it needs to address the business issues. The company may try to benchmark its own performance against that of its competitors, but this isn't easy because a lot of the financial information may not be available.

Causes

There's a difference between the symptoms and the causes of a business running into problems. Sometimes the skill is identifying the difference between the two.

There's a great deal of empirical evidence from the 1980s and 1990s (from the US and the UK) which clearly shows that the fundamental reason why businesses decline is bad management. Everything else tends to stem from that.

Internal factors, as already stated, can largely be traced back to poor management. Another common cause of decline is the lack of adequate financial controls – the company doesn't produce accurate or timely financial information, and as a result management cannot identify the warning signs, until in many cases it is far too late.

The main external issues are changes in the market demand and competition. Typically, a business stops producing what customers really want, and doesn't respond appropriately to changes in the market. This feeds into the business not being on the ball in terms of keeping up with the competition.

Invariably 90% of the causes of decline go back to poor management and the management team. Since they are responsible for getting the business into the difficulty, it is logical that changes must be made to the management team in order to get out of the problem. For this reason, there's rarely a successful turnaround that does not involve at least some changes to the management team.

Operational review of a business

From time to time, it's important that business owners take a step back from their business and review the 'state of play'. While there is no reason that this cannot be carried out internally, carrying it out from an independent standpoint ensures that it is a 'warts and all' review.

Although each review will vary in terms of scope and focus, all operational reviews focus on the future strategy to move the business forward. Too often the focus of business reviews can be on cost reduction, and although this is often a factor, it more often forms part of the process rather than a solution on its own. Equally important areas to consider in a business review are:

  • potential for shareholder return
  • business cultures both within and outside the organisation
  • the effectiveness of the management team
  • management succession planning
  • the effectiveness of financial controls.

Undertaking regular operational reviews of a business should help alert management to any warning signs or causes of possible business failure.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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