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Advice from Outside the Square

10 Tips to Avoid Insolvency

10 Tips to Avoid Insolvency

It is a tough world out there for small business at the moment. Interest rates are bottoming out yet not much consumer spending is being seen. Here in Perth, iconic restaurants and pubs are closing down, strip shops are empty, fashion labels are rationalising their stores and outlets.

While we cannot succumb to all this bad news, and we must look forward to our continued success in business, nevertheless you cannot simply ignore what’s going on. No matter how many times you visualise success, if you don’t do something tangible, those problems are going to come and get you.

So, while we don’t want to think about insolvency, it is prudent, if not necessary to work to ensure that insolvency does not come near us.

Here are 10 tips to work on to make sure that you stay well away from the red line of insolvency.

Tip 1: Understand your business’ key financial measures

Do not leave this to your accountant. You are the owner, and you need to take responsibility for ensuring that you understand what drives your business, and which numbers indicate success or failure.

First, work out what these key financial measures are. They may include the level of salaries or the ratio of salaries to sales. They may include numbers such as stock turnover days, or gross profit margins, or the ratio of hours worked to sales. Certain numbers will drive your business, where if you don’t achieve those measures the business slows down.

Get to know them and monitor them constantly. Take early action to deal with any adverse variance.

Tip 2: Prepare regular management accounts

You cannot run your business on an annual set of accounts – how can you keep your finger on the pulse that way? How can you take action when you don’t know action is needed?

If you’re running your business on gut feel about how well or poorly you are doing, you need to stop. Produce regular management accounts – and use them, review them, get to understand what they mean and what the variances between one period and the next signify.

Most small businesses will need monthly accounts, and that means you may have to upgrade your books. It’s no longer enough to keep a shoebox of receipts or to enter into your accounting software every couple of months – you need to enter information and be able to get it out within a few days of the end of the month.

Review these important information statements and act on any downward trends.

Tip 3: Monitor cashflow regularly

Cashflow is your business lifeblood. You may be profitable, but if all your profits are sitting on the shelves as high levels of stock or sitting in your books as unpaid customer invoices, you will not be able to pay your bills.

Insolvencies are caused not only by losses – many insolvencies are caused by “over-trading” where a business keeps selling but has no cash.

Decide what is appropriate for your business – the cycle could be daily, weekly, or monthly depending on the type of your business and how your cash flows. Then keep a close watch on the cashflow and on how it meets the budget. Make cashflow forecasts before making decisions on working capital requirements.

Tip 4: Prepare a budget and set realistic targets

First of all, even if you have never done it before, you must prepare a budget to try to predict your financial future. In doing so, in a volatile economy, past activity may not be a reliable guide for the future. This means, for example, that you can’t just set sales targets by taking last year’s. In the same way, you can’t set targets for your cost of goods if your suppliers are likely to increase prices or reduce credit.

Question every assumption behind revenue, cost, overheads and cash flow. Build a contingency for unforeseen events. Setting realistic targets in this atmosphere may mean that you can foresee the need to reduce costs ahead of time and take action before crisis hits.

Tip 5: Establish tight credit control

Ensure all your customers understand your terms and conditions. Make sure you run credit checks for new customers before you allow them credit. From time to time, run credit checks for established customers. Be prepared to say no to allowing credit – a lost sale because they can’t get credit from you is better than providing your goods or services and then not getting paid.

Monitor debtors outstanding regularly. Monitor debtor days outstanding to understand if the payments are getting later and later. Chase every late debtor, set payment dates with them and stick to them. Do not sell to any customer who is not paying outstanding late bills. You may be throwing good money after bad.

Consider incentives such as early payment or cash payment discounts; if not already, consider accepting credit cards.

Tip 6: Focus on your best margins

Understand which of your products or services provide the best margins per dollar sales. As well, reconsider which of your goods or services will come into demand or have more growth potential at this time.

Put your resources into those that provide the best margins or have the best prospects for growth.

Review prices and terms for products and services that are unprofitable or have low margins. Consider and review any customers that are unprofitable. Explore different ideas to improve margins.

Tip 7: Keep key stakeholders informed about bad news

If bad news is coming, banks, key suppliers and investors will be more supportive if they are kept informed ahead of the curve. If done early enough, they can help you take steps to deal with the issues. Building trust pays dividends in difficult times.

Tip 8: Involve staff in cutting costs

Clearly explain to staff what some of the financial issues are, whether low margins, reduced sales or increased costs. They are part of the community and can see for themselves how the economy is going.

Involve staff in cutting costs and identifying costs to be cut. They are more likely to rally around if they understand the reasons for the cuts and they may even suggest economies that you have not thought of.

Get staff to help you update processes and procedures to increase efficiency and if necessary, invest in IT to further increase efficiency.

Tip 9: Take a whole view perspective

Make sure that you look at all financial issues and problems with a whole view of the problem, and not just from one perspective.

For example, cash may be short because the owners once put a lot of money into the business, and now times are tough, they are taking it out. So the cashflow problem may not simply be put to reduced sales.

Once you are able to see the debt problem “in the round” you can tackle the problem holistically rather than attempt to resolve one symptom that may not be the answer to the problem.

Tip 10: Take advice early

I am not an insolvency professional but I have worked with many and they have specialist knowledge to bring to the problem.

Seek and take advice early rather than when it is too late. An accountant or an insolvency professional can stand back and see the whole of the problem with an objective view.

 

As I said at the beginning, while times are tough, you can’t just give in. Yet you can’t ignore the facts either and stick your head in the sand. The problem will not go away on its own so you must take preventative action.

Go through each of the 10 tips and make sure you take action.

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