Sep - 16 - 2019

How Businesses Die - Part of the Business Philosophy White Papers Series

Anyone who as ever owned a business, small or otherwise, knows that there are constant stresses involved with its proper management. Often, business managers and owners get so caught up in the daily stresses that they become more operationally than strategically focused. Then a day comes when they look at the cash account and there is not enough there to meet payroll. Panic ensues, and it is often followed by a graveyard spiral of debt and repayment that all too often ends in bankruptcy. This article is about the paths that lead to this situation, and how to stay off of them.

Executive Summary

When a business dies we generally say “it went bankrupt.” Bankruptcy is an expensive legal process, and most failed businesses do not go through it. The truth is that companies die because they run out of cash. They run out of cash either because they are not profitable or they were undercapitalized at startup.

Unprofitability (insolvency in the cash flow sense) is caused by one of two problems – low revenue or high costs and expenses. Having low revenue is the result of poor marketing, while excessive costs or expenses are the result of inefficient operations. Illiquidity is caused by one of three reasons – undercapitalization, inappropriate levels of accounts receivable or Inventory, or an excessive cash drain. All of the causes that lead to insolvency or illiquidity are under the manager’s control, so if the business runs out of cash it is the manager’s fault. Fortunately, there is something the manager can do to prevent this problem and, while he or she may not know it, that something is his or her job. It’s called planning.

A company with a good marketing plan will not have problems with either low revenue or excessive costs, and a company with good financial and operational plans will not have problems with excessive expenses. If the company was properly capitalized at startup then all that is left to do is keep up with the changes in the market. If the company is profitable but was undercapitalized at startup, or has been drained of cash, there may be hope in the form of a debt or equity raise to remedy the illiquidity problem but this option will depend on the company’s ability to repay the debt or provide the investors an appropriate return. If profitability is low and the business is undercapitalized, then extraordinary measures will be needed in order to save it, if it can be saved at all.

Whether in startup or continuing operations, an effective business plan is a necessary precondition to continued success. The plan is the distilled reasoning of the management regarding both the marketplace and the internal operations of the business – it documents the management’s beliefs about the company and the environment in which it operates. For the plan to be effective it must be followed.

Other than the obvious steps of doing what’s in the plan, the actual operating results must be compared to those predicted by the plan, and any deviations must be understood. Since the plan is based on the beliefs of the management, any deviations from the plan must reflect misperceptions by the management – disconnects from reality. If performance exceeds expectations then management must identify the reasons (change their perceptions) and then modify the plan to support doing more of whatever it is that is working so well. If performance does not meet expectations then management must identify what is not working (change their perceptions) and then modify the plan to improve performance.

Management, financial or otherwise, is an active verb.

The following diagram is used to provide the structure for the paper which can be downloaded here: How Businesses Die.

All Original Content Copyright 2014 Jon Bennett. All Rights Reserved.

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