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What to Know About Starting a Small Business – Part Three

February 15, 2018

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Financial Warning Signs and Options for Troubled Businesses

Welcome back to the final installment of our three-part blog series on starting a small business (click to read part one and part two). In this post we will discuss common financial warning signs that indicate your business may be struggling and explain some of the options available to assist a business get out of trouble and minimize further financial difficulties.

What to know about Starting a Small Business

Starting a business can be stressful, overwhelming and present a host of obstacles. So far in our small business blog series, we discussed some considerations for starting your own business, as well as some of the options you have for financing a business. We also discussed some of the challenges that can arise during the process of starting and attempting to capitalize a business.

According to several reputable American business publications, the general failure rate of start-up businesses is a staggering 80% within the first two years of operations. Business risks and difficulties can arise in a variety of shapes and sizes, and it’s no surprise that financial troubles are one of the greatest stressors for any business owner. Often when a business owner gets into financial difficulties, he or she feels cornered and does not know where to turn for help. It is human nature to feel pride for something we create, and sometimes it is painful to face the fact that things are not turning out how we first imagined.

To get a better understanding of where some of these obstacles might occur, let’s first discuss a few warning signs that your business may be in danger:

You are “dragging” your accounts payable

To put this in perspective, let’s looks at the following scenario as an example:

In the early days of starting his small business, Joe was able to obtain a loan and short-term financing to help him get started. Accounts payable was getting paid within 30 days, and everything seemed to be going well. However, as time went on, Joe’s revenue began to fall, and before long he was failing to meet projections and cash flow demands. All of a sudden, his payable deadlines started to increase, with some up to 120 days overdue. At first glance, Joe’s problems may seem somewhat manageable, but as creditor phone calls began to increase in frequency, the stress and severity of his financial difficulties started to show.

In Joe’s case, the inability to meet liabilities as they became due was a key warning sign that his business had a serious cash flow problem – a problem that should never be ignored.

You are not collecting receivables in a timely manner or have a buildup of inventory

A key component of working capital and cash flow management is the “current assets” side of the balance sheet. It is critical for any business, and particularly a new business, to ensure it is collecting cash in a timely manner. If customers are slow paying, or if the business is not monitoring the amount of time it takes customers to pay, it can quickly lead to problems, including the issue discussed in our scenario above.

Some ways to combat this problem are to ensure you have a system in place to evaluate potential customers’ credit worthiness, ensure your financial reports allow you to identify slow paying customers, ensure your staff is trained in managing collections and make it as easy as possible for customers to pay by providing several payment options.

Inventory is also an important part of the “current asset” side of the ledger. If your business is building up excessive inventory, this means you are spending too much (or too quickly) bringing in the product but are not selling it quickly enough to generate a profit and cash flow. A business needs to manage its inventory levels with a good financial reporting system that includes periodic inventory counts and the use of a “Just in Time” method of purchasing depending on the nature of the goods.

You are financing the business’ operations by not remitting payments to the Canada Revenue Agency (CRA)

When a business is short on cash and makes the decision to withhold a GST or payroll remittance to the CRA, this provides an immediate cash flow boost. Most business owners who are forced into doing this are not trying to be dishonest, but instead truly believe that they can make up tax remittances in arrears in future months. As we discussed above, it is human nature to believe there are better days ahead and that we can overcome any challenge. Unfortunately, our experience tells us that once a business gets behind on tax payments, the reality is that the problem is more likely to get worse in the future. The CRA has a number of collection actions under federal tax legislation, and at some point, if the tax debt gets large enough, CRA is likely to pursue some sort of collection process. These collection processes can include bank account seizure or garnishment, asset seizure, filing liens or judgments on property, etc. If you are faced with any of these unfortunate repercussions, the outcome can be fatal to the viability of a business.

You continuously seek higher credit or are using personal credit to support the business

Have you found yourself asking existing suppliers for a higher credit limit, or are you trying to find new suppliers to increase purchasing or spending limits? You may be forced into doing this because you are not able to obtain other financing. Alternatively, and we see this often, a business owner may start using personal credit cards to finance business purchases or leverage personal assets (e.g., home equity) to generate cash for the business. This can turn into a serious problem if the business is not viable because the related debts incurred in a personal capacity suddenly put the owner into personal financial difficulty. For incorporated companies, this effectively eliminates the “corporate veil.”

Your financial records are in shambles

Sometimes a business owner thinks their business is humming along nicely and profitably. The business is constantly issuing invoices for products or services to customers and is routinely collecting receivables. It appears that things are going well and that the business is successful. Then one day the bank account balance appears very low and confusion sets in. The reality is that many small business owners are too focused on driving the business, but are not as focused on financial reporting or monitoring. Many small businesses have poor recordkeeping and accounting systems – this is an inevitable way to quickly lose sight in a business

While some of the problems discussed above can seem daunting or overwhelming, they can be overcome with the assistance of a Licensed Insolvency Trustee. At Smythe Insolvency, we can’t stress enough that the earlier financial problems are addressed, the easier it becomes to manage the situation and come up with a viable recovery plan.

To put financial freedom in perspective, let’s review a few options available to businesses that are facing financial challenges.

Attempt an “informal workout”

If financial troubles are addressed early enough, it may be possible to come up with an “informal” plan to restructure the business’ affairs and get back on track. By “informal” we are referring to not making use of formal insolvency framework under the federal Bankruptcy and Insolvency Act (BIA). Smythe Insolvency’s Licensed Insolvency Trustees can help you perform financial forecasting and business planning, while also assisting with creditor negotiations to help you come up with a workable payment plan. This option is best suited for situations where there are a small number of creditors and/or a relatively low amount of total debt.

File a proposal under the Bankruptcy and Insolvency Act

Under the BIA, both an incorporated company and an individual operating as a sole proprietor has the option to file a proposal, which is akin to making a formal payment offer to creditors, often at a significant discount to the total debt load. There is no limit to the amount of debt that can be restructured in a proposal, making this a good option for businesses that have amassed an unmanageable amount of debt. By filing a proposal, business can restructure their affairs by having creditors compromise their claims so the business can continue with a fresh start.

Businesses can become insolvent for any number of reasons, including bad timing (e.g., heavy investment in a new product coupled with lower sales volumes) or an adverse market condition (i.e., a major customer goes bankrupt). In order to save their business following an unexpected downturn, many owners choose to file a proposal. A proposal is a highly-effective and widely-used framework which allows a business to continue its operations and stay in control of its assets while being monitored by a Licensed Insolvency Trustee who, as an objective third party, can provide the creditors confidence that the business is viable, and that the proposal offered is a fair solution for all parties.

There is also an additional framework under the BIA called a Notice of Intention to make a proposal (NOI). A business can file an NOI prior to making a proposal and get an immediate stay of proceedings (i.e., creditor protection) for an initial period of thirty days while it organizes its affairs and formulates its ultimate proposal. The NOI is an effective tool where there is some immediate urgency (e.g., a creditor preparing to seize assets) that justifies granting the business time to develop its proposal.

File a bankruptcy under the Bankruptcy and Insolvency Act

Sometimes a business is simply in too poor a financial state to be saved and the business owner needs to find a way to exit the business and provide the best remaining solution for the creditors in an otherwise unfavourable situation. A bankruptcy, despite the negative connotation of the word, is a commonly-used legal framework for companies who will not survive, to distribute their remaining property in an orderly fashion for the benefit of all creditors. A bankruptcy will generally only be used in cases where a business cannot make a viable proposal to creditors (i.e., there are few remaining assets), the prospects of success for a restructured business are very low or the business owner has simply lost the will to continue funding “good money after bad” and recognizes the business has failed. Smythe’s Licensed Insolvency Trustees have significant experience helping small businesses and owners navigate their way through the difficult, and often emotional, process of a “forced liquidation” scenario, and can help minimize any further financial losses or reputational damage that can be caused as a result of the financial failure of a business.

If you or someone you know is struggling financially, it’s important to ask for help early on. Our team of licensed professionals will work with you to evaluate your financial situation and discuss how each option will affect you, your payment requirements and other obligations. Allow us to make recommendations to develop successful strategies for achieving financial goals and overcoming setbacks.

Contact us today for your free, no-obligation consultation and get on the road to financial freedom.

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