From time to time, there are catastrophic events that can have an impact which perhaps could not have been either foreseen or planned for. Many would place September 11 in this category. Others would say that following September 11, we should plan for ‘worst case’ scenarios in any business activity. Sometimes it is not appreciated that one event, say the Hatfi eld rail crash, can have unexpected and indirect consequences. Taxi drivers in Doncaster and York lost thousands of pounds of business in the months following Hatfi eld. London trains still ran, and still made their usual stops – but they were carrying very few passengers. It was a long time before passengers returned to the high-speed railways in large numbers. None of that was ‘planned for’ and many failures followed.
Usually, however, company failure is gradual, painful and, in the end, seen as inevitable. There are three distinct stages, namely:
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poor management structure,•
bad operating decisions and•
the fi nal few weeks or months.Failure begins with a poor management structure, or with a change in a manage-ment structure or role which defl ects from doing the correct thing:
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Autocratic boss: He often has spectacular success initially, particularly if in the wake of some invention or niche market penetration. Soon, however, his overbearing style loses good people and those who remain fail to do the right things for fear of incurring his wrath. The outward sign is of functional heads being constantly overridden instead of being allowed to do what they154
are employed (and paid) for. In some very large publicly quoted organiza-tions, this symptom is often misleadingly encouraged by the fi nancial media, who like ‘characters’, but is fortunately tempered by shareholders looking to safeguard their investment.
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Chairman is also Chief Executive (especially if also an autocrat!): Ideally, a company chairman should be the elder statesman who keeps an eye on the whole set-up, especially on the actions of the Chief Executive, and advises the board accordingly. When the CE lacks a separate chairman, the com-pany can lack direction in a crisis.•
Weak directors: Directors are employed to run a company for the sharehold-ers and their actions must always comply with the Companies Act, and other Acts of Parliament. In addition to satisfying shareholders (the owners of the business) and also lenders, directors are required, under the Insolvency Act, to have joint and several responsibility for running the company. It used to be that a Sales Director, Production Director or similar non-fi nancial offi cer could plead a certain amount of ignorance about the fi nancial health of the company. They left ‘all that sort of thing to the fi nance man’. Any director of any limited company, whatever his or her specifi c role within the company, has a joint responsibility for the legally correct running of the company. The real problem with inadequate or ‘fi gurehead’ directors, notwithstanding their legal obligations, is that they may not apply skill, forward planning or the clout needed at the right times to achieve the right results. They are out-wardly visible as reacting to crises rather than proactively avoiding them.•
Unbalanced Board of Directors: A balanced board has Directors with execu-tive authority for each major function, for example, sales, production, tech-nical, fi nance. Over time, some companies promote a surfeit of one kind, such as engineering experts in a technical company, at the expense of other skills needed on the board. Not surprisingly, the boards of failed companies often exhibit a complete absence of any fi nancial skill.•
Management gaps: There may be a lack of senior supervision between di-rector level and working staff, resulting in a severe communication gap in both directions and, usually, poor morale at the working level.•
No cash planning or business strategy: Some companies have no annual budget process to plan operations or expense levels; no structure for report-ing monthly results and no analysis of variances to enable corrective action to be taken in good time; no cash fl ow planning or day-to-day control of it.Indeed, far too many companies have no perception of the cost of credit and the effect of late payment on profi ts, and those companies usually do not see any problem accruing from overdues. An unbalanced board typically believes that future volume will take care of past losses.
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Inability to change: Older companies or those using old technology often fi nd it diffi cult to modernize, whether intellectually or in terms of fi nding the neces-sary investment. They lack the ability to keep pace with market trends (as well as with manufacturing, production and distribution techniques), and soon lose market share and go into decline. This inability to change is often very closely associated with an autocratic boss, weak directors and management gaps.155 None of the above are mutually exclusive, indeed, as pointed out in the last bullet point, there is very frequently a combination of these features in the fi rst stage of company failure.
The second stage, and very much the end of the beginning and the beginning of the end, broadly comes under the heading of bad operating decisions:
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Over-borrowing: Through lack of management, some companies borrow more and more until the cost of servicing loans exceeds any profi ts being made. When the bank becomes worried (as banks do), they will insist on a reduction of their loan. When that happens, companies in this situation fi nd that there is no way to raise money or to cut spending quickly enough; nor is there any external confi dence in further investment.•
Over-extended contracts: In an attempt to put things right, some companies take on very large deals which turn out to be beyond their scope to perform properly.•
Too-fast expansion: Another way that companies in trouble try to put things right is to expand sales signifi cantly by discounting prices to get the volumes needed. This cannot produce either the cash fl ow or the profi t soon enough to keep the now larger creditors paid or to service short-term loans. In any case, if margins are already tight, taking on signifi cant extra work on an un-improved cost base is hardly going to lead into un-improved profi ts.•
Borrowing short-term to fi nance long-term loans: Fixed assets are there to produce sales over many years and should always be fi nanced by loans over similar periods. A company soon gets into trouble when it has to borrow new money at short notice to pay instalments falling due. The period of repay-ment of loans should always match the time that assets produce income.The third distinct phase in the downhill slide towards failure manifests itself in the more obvious and recognizable symptoms of a very sick company. Some of these symptoms can in fact be displayed by companies not necessarily on the brink of failure, but taken together, and following stages 1 and 2, there can be little doubt that the end is nigh:
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Excuses for late payment: Payment promises not kept and increasingly weak excuses given. Very obvious avoidance of taking phone calls, and/or not answering letters, faxes and emails.•
Signs of poverty: Premises and equipment become poorly maintained for lack of funds; staff morale declines because of cut-backs, pay problems and worry about the future of their jobs.•
Image problems: These are soon evident in complaints about quality and delays in customer service, resulting in lower order levels from major buyers, who soon fi nd more reliable sources. Quality complaints themselves can arise due to the failing company sourcing inferior materials from wherever it can get them, as usual suppliers exercise stop list options.•
Creative accounting: This is seen only when there is access to fi nancial ac-counts, revealing profi ts boosted by questionable treatment of stock values,156
low depreciation compared to previous practice, invoicing in advance of completed contracts, and many other dubious entries. Creative account-ing was taken to new heights in the Enron scandal, followed by many other company revelations of ‘black holes’ in their accounts. This alone is enough to bring even the mightiest edifi ce crashing down.
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Bad ratios: Balance sheet analysis shows severe deterioration in main ratios since the previous period, often quarterly or half yearly, especially lower net worth and a poor quick ratio or acid test.•
Legal action by creditors: This is publicly evident in County Court Judgments and High Court writs. In trade circles, there may be news of joint action with Statutory Demands, often leading to winding-up orders.•
Resignation of key people: This may be actual or rumoured, especially of directors who can say later that they were not directors when failure oc-curred.It is not diffi cult for even less experienced credit managers to be able to see the stages in the decline – the sequence may be somewhat disjointed, some features will be missing, and some more prominent than others. But the end result is the same – failure.