Too much success may be bad for your company's health.
Is it possible for a company to have too much success? Can it have too much new business, sales figures that are too high, and a bottom line that is too good for the health of the company?
It can happen, particularly if success covers up serious problems so that they are pushed under the carpet and ignored. The company may be too busy moving forward to take care of essentials such as maintaining timely financial information and paying its payables as they come due. Entrepreneurs who concentrate on sales or production often don’t appreciate the necessity for timely financial information, and often don’t make use of it when it is provided.
Many companies, particularly in the IT sector, discovered this once the high tech “boom” ended. Wild success stories became question marks, and eventually became have-beens. Observers picking over the wreckage saw the signs that pointed to imminent failure, but it was hard to notice those factors when times were good. Even if someone had pointed out the problems, that warning may not have received the attention that was warranted.
There are many reasons why companies fail. However, by watching for signs of trouble before they happen, a company can take corrective steps now that can save it from disaster later.
Lack of accurate, current financial information
While it sounds basic, this is one of the most important indicators to look for. Take the case of a travel wholesaler that acquired a tour operations company that looked good (its interim financial statements showed a slight profit). It was not until a year later that auditors discovered bookkeeping errors, which led to significant unexpected losses. Because the wholesaler did not have timely and accurate financial information, it spent an entire year not knowing issues needed to be addressed – resulting in the company going bankrupt.
A case like this indicates that without accurate financial information, a business does not know where it has been or where it is going. Its decisions are apt to be based on totally wrong assumptions. A company might assume that its flagship product is a moneymaker, while in fact there are many “soft” costs associated with it, resulting in the product being sold at a loss. Accurate financial information would allow the company to realize changes were required.
Information must be timely for management to make decisions quickly in response to changing circumstances. A company might even find with up-to-date financial data that it has a cash surplus and can take advantage of a sudden opportunity.
Companies need to instill the discipline of requiring periodic financial statements, cash flow projections (and then comparing actual performance to budget), aged accounts receivable and payable listings, and other financial information. By comparing different financial periods and carrying out a financial ratio analysis, a company can spot trends and be alerted to problem situations before they have an impact on the business. Cash flow forecasting identifies future cash requirements that need to be anticipated in the planning stages to be dealt with before they occur. Delay in providing financial information is also a telling symptom of financial difficulties. Creditors, especially a company’s banker, assume that late delivery of financial information is a warning signal of problems brewing at the company.
Fortunately, it is becoming easier for companies to develop good financial reporting. Information that years ago would have taken an army of bookkeepers to compile can today be done by one person using a good computerized accounting program.
Lack of management depth
Difficult to define, either a company has management that is up to the task, or it does not. The “right” management depends on many circumstances, one of which is the stage at which the business is operating. A start-up, for example, requires quite different management skills from an established company.
Management is always a key issue when a company is having difficulty. This can be seen in one-person rule, a board that has little input into decisions, an unbalanced administrative team or a weak finance function.
Good people will not stay with a business that fails to provide them with responsibilities that are challenging yet not impossible. This means that employee turnover, particularly at a management level, is a key indicator of a company’s health. Poor management usually indicates that a company has deeper problems as well. An assessment of the overall management skill set is essential.
By comparing different financial periods and carrying out a financial ratio analysis, a company can spot trends and be alerted to problem situations before they have an impact on the business.
Changes in accounting policies
There’s an old joke that a good accountant is one who can make your bottom line whatever you want it to be. The reality is that, while in some cases there are good reasons for changes in accounting policies, the changes may indicate that some financial “shell game” is going on. It is often possible for a company to change its method of accounting as a means of artificially maintaining profits or minimizing losses when faced with financial difficulties. Even if a company operates within generally accepted accounting principles (GAAP), changes in its application of these standards are often suspect. As well, it is only with consistent reporting and financial presentation that a company can get a clear picture of where it has been and where it is going.
Slow or unsystematic payment of trade creditors
If a company is lurching from one crisis to the next, this quite often shows up in how it pays trade creditors such as printers, material suppliers and couriers. If it is unable to take advantage of available purchase discounts, abuses supplier credit terms and ends up paying penalties on overdue bills, it is a clear sign of trouble. Either insufficient cash is available to make payments, or management is distracted and paying costs that need not be incurred to keep the business viable.
Other signs
Other trouble signs include:
- Build-up of government creditors in areas such as payroll source deductions and sales taxes;
- Persistent operating losses;
- Under-capitalization;
- Excessive build-up of receivables, reflecting poor cash management; and
- Borrowing regularly near the established credit limit.
The antidote – a good business plan
Having a good business plan, and sticking to it, is one of the best ways to stay out of trouble. It is more than a document that helps deal with financing sources. A business plan is a combined roadmap, schedule and compass that allow you to compare where you are now to where you want to be. If detailed enough, not only does it force management to commit to the steps towards the company’s vision of the future, but it is also a tool for discovering when the company may be off the tracks or behind schedule – and may provide some clues or early warning signals as to how to get back on the rails again.
Bryan A. Tannenbaum, FCA, FCPA, FCIRP is a Partner in the Restructuring and Recovery Services group in the Toronto office of Collins Barrow.
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