Reading the danger signals

More company failures may be in the wind. GARETH HOOLE advises how to recognise the signs that all is not well.

Terralink, Hartner Construction and Real are the three most recent receiverships to make headlines, and the feeling is that they will not be the last.

Usually when a receivership or liquidation appointment is publicised, it takes by surprise many interested parties, including the staff, leaving them wondering how things could go so wrong so quickly.

However, businesses seldom fail overnight, and the problems have usually existed below the surface for some time. Commonly, though, management has not recognised the symptoms of ailing financial health until too late.

Most businesses will, at some time, experience difficulties and show signs of weakness. Not every one is doomed to fail, however. A great deal depends on how soon managers recognise the warning signs and take remedial action.

Is your business immune to the arrival of a receiver, or, worse still, a liquidator, on your doorstep?

Or are there warning signals of which you are not fully aware, and which, left unchecked, may lead to dire consequences?

The costs of a business failure are not always immediately quantifiable and they usually have far-reaching implications.

Not only is there a cost to the owners, who have lost their investment, but most of the other stakeholders end up counting the cost.

Some may be fortunate enough to hold some form of security or rank as a preferred creditor, but there is no guarantee that they will realise their full claim. There are situations where liquidation proceeds do not cover the security, leaving the creditor out of pocket.

In most liquidations the unsecured creditors come away with little, if anything, and the shareholders, who stand last in line, get nothing.

Business failures lead to job losses and they can have a domino effect, causing related businesses to suffer, too.

In the Hartner case, dozens of subcontractors face an uncertain period while the receiver does his work. Some had their own businesses riding on the success of one project and could be staring at collapse themselves.

Most businesses in New Zealand are classed as small or medium-sized, and the effect of a substantial bad debt can be severe.

When a business fails, the costs cannot all be stated in dollars; the situation can take a heavy emotional toll on the people involved, causing stress, relationship breakdowns and other social problems which can have long-lasting effects.

The causes of corporate collapse are many, and it goes beyond the scope of this article to examine them in detail.

However, studies of business failures over the years have shown common characteristics. Some are caused by factors completely beyond the control of management, such as large-scale economic downturn or radical changes in the market.

In most cases, though, outside factors seldom cause the collapse - they are merely piled on to internal woes, causing the burden to become too heavy to bear.

Had managers fixed problems over which they had control as they arose, bad external influences could at least have been mitigated, if not completely overcome.

What, then, are these early warning signals of which the astute manager should be aware? The signs listed are merely indicative and by no means exhaustive.

Some of these indicators will be immediately evident through an examination of the accounts of the company, but many others will not be directly related to the financial function of business.

Some may be brilliantly obvious; others require far deeper analysis.

The starting point for a scrutiny of the warning signs is a detailed review of the management accounts, budgets and cashflow forecasts of the enterprise, but these could constitute a warning signal in themselves.

The absence of regular and timely management reporting, a sound budgetary control function, with regular comparisons between the expected and actual outcomes, and detailed cashflow forecasting is a significant concern.

Managers of an enterprise without these mechanisms in place will probably not possess some of the most basic information essential to the running of a healthy business.

Always remember the adage: what you can measure you can manage.

Some of the other warning signs to observe are listed in the table at left.

These signs are just some of the indicators which might reveal that all is not well and that some remedial action is necessary to avoid collapse.

Typically, though, it is difficult for managers who are actively involved in the daily operations of the business to undertake such a self-critique and identify the warning signs, which could be their own fault.

In the same way that one regularly visits the dentist or doctor for a check-up, or preventive maintenance is done on motor vehicles, businesses should be given the once-over from time to time.

A business can pay out thousands of dollars each year for insurance, giving its owners peace of mind that its assets are protected.

A strong argument exists for businesses to obtain periodic health checks as a means of protection against collapse. It is another form of insurance, guarding not only the assets of the owners but the interests of other stakeholders. The costs of the alternative are too high to be taken lightly.

* Gareth Hoole is senior manager of client advisory services for Staples Rodway in Auckland.

VITAL SIGNS


Signs to watch for if you are worried about your business:

* Declining trends in key financial ratios and business performance indicators, such as the return on investment and financial gearing ratios.

* Tightening liquidity, which means less cash is available than the business needs. Signs are a consistent testing of overdraft limits, endangering banking covenants, and the need to stretch out payments to suppliers.

* A lack of, or a departure from, a formal system of internal controls.

* Disgruntled personnel, high staff turnover and labour disputes.

* A loss of market share and a failing to keep up with market trends and technology.

* Regular bottlenecks and disruptions within the production process.

* Poor or deteriorating relationships with lenders.

* An over-diversification into activities away from the core business.

* General stagnation and a lack of innovation, with dictatorial management frequently the prime cause.

* Over-reliance on a single project.

* The absence of a clear plan for the future and operating without a definite business plan.