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Reasons Businesses Become Insolvent?

Reasons Businesses Become Insolvent? Author: John A Waller. Reviewed: June 29th, 2024.

Why Do Businesses Become Insolvent? Individuals do not start a business anticipating failure. Although starting a business can be exciting, succeeding requires detailed, achievable planning while correctly setting out your business stall.

Sadly, a failing business has a habit of not letting the directors know until it is too late. Often, even when directors know, they delay approaching an Insolvency Practitioner because they have something to hide: shame, fear, or sheer ignorance. So act quickly and explore the opportunities to save the business. We at HBG Advisory are approachable and are here to help. Do not stay in a denial phase. Act quickly, preferably today. Let’s work together and move on.

Sadly, many use business funds as personal funds—your business is not your personal bank account, especially with a limited company.

So, what are the Reasons Businesses Become Insolvent? Though not exhaustive, more exist, but these rank high.

1. Poor Business Cash Flow.

2. Insufficient working capital.

3. Highly Competitive Market Place.

4. Team migration.

5. Bad debts and poor credit control.

6. Client migration.

7. Poor management of business finances.

8. High operation costs while establishing the business.

9. No knowledge of operating a business.

10. My bank is withdrawing my overdraft facility.

So, no matter how profitable and stable your business is, maybe any of the above points, taking your eye off the ball and falling into a false sense of security can cause any company’s solvency to change quickly over a short period.

An excellent example is the hospitality sector in the UK and worldwide. Coronavirus has ruined many fantastic companies. Take care!

Businesses enter Insolvency in the UK for many reasons. Companies may fail due to a cash flow emergency created by clients not paying or extending credit terms without approval. 

Even during prosperous times, remain on guard, as Insolvency is just around the corner. Sadly, recent failures during the coronavirus COVID-19 pandemic demonstrate this. Therefore, ensuring you can secure your business is vital!

Please read What is Insolvency for a more in-depth look at its meaning.

Let’s review ten typical reasons a business may fail once it is trading profitably. Read on and hopefully steer clear of Insolvency.

Reasons Businesses Become Insolvent? Ten Reasons:

  • Poor Cash Flow

When your business is performing well, it’s easy to believe that you may withdraw substantial monies from your business without harming its future.

However, business changes happen quickly. Revenues fluctuate month by month, and a sudden plummet without cash reserves can cause your business to fail!

Always maintain adequate reserves. The yacht can wait. Sadly.

  • HMRC;
  • Landlords.

And other vital expenses will not.

Fighting with Business Cash Flow issues can suddenly happen for many reasons. Unexpected tax bills from the HM Revenue & Customs for unpaid arrears of VAT remain a common problem. However, this should be part of the company’s cash flow spreadsheet and not an excuse. Poor management. If you have tax arrears, contact the HMRC as soon as possible, schedule a time with them, and arrange a payment. Failing to do so may sink your business.

Avoiding a cash flow crisis is perhaps the primary function of any company director.

Up-to-date financial records, preferably computerised with a reputable accounts package, allow directors to predict problems that are often heading their way. It is wise to keep a cash reserve to see the company through difficult times. However, not everything goes according to plan, and cash flow can still go out of control, no matter how well managed. Then, insolvency looms.

  • Insufficient working capital.

Having insufficient working capital may stem from:

    • Low initial capital was introduced on day one;
    • Operating costs exceed revenue.
  • Highly Competitive Market Place.

Entering a highly competitive marketplace normally forces sales prices down. However, costs may remain or, indeed, grow over time. Profit percentages drop and fixed and variable costs absorb the gross profit, leaving little net profit and impacting cash flow again.

  • Team migration.

Once a business establishes itself and demonstrates profit, competitors will try to poach essential team members to add value to their business or set up direct competition. To defend your company against such actions, it needs robust HR management and a well-structured reward system. Failing this will leave holes in your team and destabilise the business.

  • Bad debts and poor credit control.

Failing to operate proper credit control of the companies’ sales ledger and allowing debtors to extend payment terms are the top two reasons for its failure. Further, this may enable bad debts to occur when your eye is off the ball.

  • Client migration.

Problems with quality control, late deliveries and poor pricing can lead to essential clients migrating to new suppliers. Ensure your manufacturing team maintains quality check audits. Your dispatch team liaises with production and sales to deliver on time. Everyone closely monitors costs and prices while always operating a robust competitive analysis.

  • Poor management of business finances.

You would be surprised how many companies fail purely due to insufficient management of business finances. Ensure you liaise with your accountant and understand your business finances.

  • High operation costs while establishing the business.

When commencing a new business, operating costs may exceed revenue until the business is considered up and running. However, the cost continues, and business profits may not catch up, causing company failure. Therefore, you understand your projected Profit and Loss accounts with Balance Sheets and Cashflows.

  • No knowledge of operating a business

So many individuals start Limited companies without comprehending the onerous implications. They see the phrase “LIMITED LIABILITY” and yet have no understanding of what limited liability meaning? However, this only applies if you have complied with everything.

Please read:

Running a limited company is challenging, and saying later on you did not know is no defence. Indeed, if you do not understand why to assume a director’s role, employ a suitably experienced individual who understands.

So then, if your business risks Insolvency due to Reasons Businesses Become Insolvent?

For many business owners and directors, becoming insolvent is unthinkable. With steady revenue and substantial profits, it seems impossible for your company to face a severe cash flow crisis one day.

However, many of the world’s most profitable and successful businesses have faced cash flow issues, in some cases insolvency and bankruptcy with short notice due to the loss of a critical client or poor cash management.

If any of the above problems sound familiar to your business, you must act now to prevent further development. Preventative measures are the best way to limit Insolvency risk and ensure your business’s healthy future.

So, if you require some clarity, help and support on any of the above and receive free advice on ‘What is Insolvency

Please contact HBG Advisory for FREE Company Debt Help and Advice on:

FREEPHONE 0330 056 3120

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