Top 5 causes of business insolvency and how to avoid them

Top 5 causes of business insolvency and how to avoid them

April 25, 2019 by Sandra

business insolvency

With running a business, there is always going to be a certain amount of risk involved. It’s just a fact of life. However, managing these risks requires a certain skill set, plus, it’s useful to understand the causes of business insolvency to know what to look out for. It’s a well-known fact that over 50% of business fail within their first 3 years, but the risks that contribute to start-ups don’t suddenly disappear after those crucial first years… they’re ongoing.

So what can you do to protect your business from insolvency? No matter how long you’ve been in operation, it’s vital to be aware of what insolvency is, and how you can avoid it. So, that’s why, in this post, we highlight the top 5 causes of insolvency, and what you can do to stay well clear of them!

1. Loss of Cash Flow

The number one thing, and probably one of the most common causes of business insolvency, is the loss of cash flow and sufficient funds. It seems simple: always have enough money. However, like most things with running a business, it’s never really as easy as it seems.

A loss of cash flow can happen over time - with things such as credit problems, accumulating bills, and payment delays building up, it can be difficult to keep on top of everything while ensuring there is enough cash in the bank. Even if your business is doing very well, and is bringing in great profits every month, it’s so important to keep enough cash aside to cover expenses such as payroll, inventory, production, taxes and other essential costs. Also ensure that you have some extra cash to spend on anything unexpected, such as hardware failure.

Always, always keep on top of your finances. Hire an accountant to help if needed - cash flow problems could happen at any time, without notice. If you fail to keep track of your company’s expenses, a small downturn in profits could be enough to wipe you out.

2. Increase in debts

Of course, too much debt results in cash flow problems, which we now know is one of the main causes of insolvency. You may have borrowed money to start up your business, as many others do, however borrowing a large sum is likely to increase the risk; just one month of poor sales could be all it takes to cause your debt repayments to exceed your overall income. So, make sure you plan ahead by always keeping that extra bit of cash aside to deal with any problems further down the line. Minimise any further loans, especially if you’re a start-up - after all, the more debt, the greater the risk.

3. Loss of a big client or customer

Some businesses rely on just one or two customers for a large percentage of its profits. Becoming reliant on a particular client or customer faces a serious risk if they decide to switch to one of your competitors. What would you do in this situation? Such a huge loss of profit could land you in real financial trouble, so assess what you can do to ensure the retention of these all-important customers, or focus on acquiring new ones. The latter will give you alternative sources of income, should your larger client or customer move away.

business insolvency

4. New competition

New businesses are entering the market all the time. But competition isn’t always a bad thing - in some ways, it validates that your market is worthwhile, and challenges you to make your business better. However, what isn’t a good idea is ignoring them completely: growing competitors could result in a loss of market share, and therefore a loss in profit - making this a common cause of insolvency.

So, keep an eye on your competitors, whether they’re old or new, and prepare ahead of time. Assess their value and benefits, and better them. To ensure your business revenue remains unaffected, focus on retaining the customers you’ve already acquired. Loyal customers will provide you with a safety net, even if competition increases.

5. Lack of knowledge of business practices

A business practice is a procedure by which a company follows in the pursuit of its objectives. A good practice strategy can help your business to become more competitive, increase sales and revenue, improve your employees’ skills, reduce costs, and more. So, getting basic business practices wrong could result in serious consequences. For example, poor management of employees could lead to the loss of staff, which in turn puts pressure on the business as a whole.

To avoid getting caught out, ensure that you have a thorough understanding of business processes and procedures. Some things are easy to get wrong, too - entering a contract without being fully aware of the contractual obligations is a common, yet serious, mistake. So, be thorough, be open to adaptation, and focus on detail!

What to do if your business becomes insolvent

Whether your business is showing early warning signs of insolvency or has already fallen into it, McAlister & Co. can help you. We are expert Insolvency Practitioners and aim to provide support and solutions for individuals and companies who are facing financial difficulty. We’re always on hand for free, immediate and confidential initial advice, so contact a member of our team today if you’re in any doubt.

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