Primary Cause and Reason Companies Face Financial Distress
The main factor behind a business facing financial distress is Management. This is true of nearly all the business rescue operations we have been involved in over the past 2 years. In most types of businesses including privately, publicly and family owned entities and those where external investors act in a non-executive capacity, Management being at fault is the common thread.
Management is defined as the people and activities associated with running a company, such as controlling, leading, monitoring, organizing, and planning. Specific roles and responsibilities vary depending on the hierarchical structure of the organisation and in larger companies these roles should be segregated to minimise the risks. Executive directors are the leadership and have overall responsibility for the future strategy of the business and they report directly to the board. General management implement the CEO’s plans and they control the overall running of the daily operations, while middle and junior management run the daily tasks associated with the operating activities. Most large corporations make profits despite the successes or failures of Management simply because the sheer size of the company makes it easier to hide the flaws.
Causes behind business failure
The causes behind business failure can be attributed to both internal and external factors. Management are in control of the internal factors and must aim employ a consistent approach to the running of the business. The impact of external factors –the economy, technical developments or changes to the industry and how the business reacts to them is entirely up to management. Mistakes made by management The most common mistake made by leadership is often not taking proactive action when there are early warning signs that the business is facing distress. These are the results of the impact of poor leadership:
- Management becomes dysfunctional by being inwardly focussed and not admitting to the problems facing the business.
- Ignoring and not paying attention to the information and details provided by whatever information systems they have which are indicating the business is facing financial distress, for example:
- The decline of profits and margins over an extended period of time.
- The lack of liquidity, and cash flow constraints.
- The lack of forecasts in terms of planning, cash flow and budget.
- Discounting or ignoring the advice provided by the internal and external accounting personnel resulting in lack of trust.
- Instead of managing the business according to carefully considered planning, management loses control and then has to fall back on crisis management and have to extinguish fires all the time.
- Communication with other managers and employees is limited and irregular or no meetings with the other managers are held. This also results in a lack of trust and demotivation among employees. This then results in the resignation of key personnel, and in fact personnel throughout all the levels of the company which further demotivates the remaining staff.
- Board disputes, director resignations and shareholders not prepared to assist with further funding.
Examples of attempts made by management to rectify situation
In a number of instances we have found that management have been aware for quite a while that the company is, or may be facing distress, but haven’t taken any action because they are in denial about the seriousness of the situation. They very often believe they can trade out of the difficulties as they have done in the past, or that one big deal will provide the much needed boost. These assumptions do not always materialise and the business continues on its downward spiral. Various other strategies and interventions are employed that often lead to a worsening of the situation:
- Aggressive selling and marketing initiatives to increase turnover at the expense of the margins and profits.
- Throwing money at the problem through borrowing additional funds which often leads to the liabilities exceeding the assets. This means the company is then trading under insolvent and illiquid conditions.
- Deferring payments to creditors and funders and making special arrangements with certain suppliers.
- Taxes are not paid timeously leading to penalties and interest claims. That then leads to tax clearances certificates being cancelled. In some industries, this means that the business will not be awarded tax clearance certificates in the future, even if the financial distress is a thing of the past.
Management must pay attention to the information provided to them on a regular basis and then deploy resources to take action immediately in order to ensure the risks are adequately managed. They need to identify the challenges that exist in sustaining the business and have a coherent approach in overcoming them as they occur. Communication with the other employers is vital and meetings must be arranged regularly. Companies cannot be managed from the board room. In some instances, the leadership must become involved with the day-to-day activities of the business. A team approach works even if, in the case of a small business, work can be outsourced either to freelancers or other external resources. At the first signs of distress, take proactive remedial action immediately. If you are uncertain about what to do, there are a number of advisors and turn-around experts that can assist.
Rather take action than no action at all in order to save the business and avoid unnecessary legal action and the business failing. Try not to make emotional decisions – think rationally and logically. Make sure you are totally familiar with the first signs of a business sliding into distress.
As business strategy specialists we have the expertise to put your business back on track or implement business rescue solutions.
At Fluense we will provide you with the means, knowledge and opportunity to grow, turn around or rescue your business. We can apply our expertise in any business no matter the size or industry.
“Your business is doing okay but you know that it has the potential to grow beyond your wildest expectations”
“Your business is just not making a profit and your cash flow is non-existent; you’re even feeling the pressure from creditors and lenders”
- We partner with you and provide you with a consultation.
- We review and assess your business’s performance to determine the intervention required.
- We develop transformation strategies, which we then implement in alignment with the needs of your business.
- We provide an in-depth analysis and assessment of the problem areas and what’s causing them with an emphasis on cash management.
- We develop and implement turnaround strategies that may include operational changes, reduction in costs and expenses, retrenchments and repositioning of the market.
- We will more than likely implement a restructuring of the organisation with a refinement of leadership roles and management structures.
- We will appoint a Business Rescue Practitioner to effectively take over the supervision of your company – this person will compile a business rescue plan for adoption by creditors, shareholders and all other stakeholders.
- We will negotiate with all the affected parties including management, employees, customers, suppliers, debt holders and legal organisations.
- We will assist you in liquidating your business if it is beyond rehabilitation.