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Critical Care for Companies® Turnaround Step 2: How Do You Know That Your Business is in Trouble? Why you should read this section
· There are tools to determine if your business is in the Zone of Insolvency and it is important that you know this · You will learn a concept called Fraudulent Conveyance and how this can land you in jail if you are not careful Causes of Business Failure versus Symptoms of Business Failure In Turnaround step 1, you were exposed to a number of causes of business failure. In this section, we will focus on symptoms. This will assist you in determining the degree of trouble your business is in. Symptoms of a sick or failing business include:
· Low morale of employees and higher then normal turnover · Nervous banker with possible threats of calling your loan · Flat sales or worse, declining at a significant rate · Always fire fighting and problem solving · You find you are continually in a crisis management mode · Perhaps a confused sense of direction or no consistent strategy for the business How sick is your business….are you in the Zone of Insolvency? First of all, what is the Zone of Insolvency? While there is not a clear-cut test for insolvency, a corporation or business can be said to be in the "zone" or "vicinity" of insolvency if its liabilities exceed its assets (balance sheet insolvency) or it is unable to pay its debts as they come due (equitable insolvency). It is time to dig into the financial statements, specifically your most recent Balance Sheet. Before you do, however, you must be very confident that your financial statements are accurate. This can be one of the biggest problems with distressed businesses. If the financial statements are not accurate, then the remainder of the Critical Care for Companies™ Turnaround Program will be very difficult to pull off. How do you know if your financial statements are accurate? Most failed companies have non-existent or poor financial reporting systems. Your company may lack accurate information in three critical areas: profits, costs and cash position. Without good budgetary controls, you never know how profitable you are or even if you are operating above or below your break-even point. Without a good costing system, you won't understand how key activities relate to your bottom-line profits. And without good cash flow projections, you can never anticipate the next peak demand for cash or how you will meet it. Businesses that operate without audited statements are far more prone to financial distortions, whether intentional or not. Your statements may be nothing more than erroneous information. Now is the time to review your financial statements-perhaps with the assistance of your accountant. Note: many accounts are very good at preparing taxes but not good at financial analysis. This is a critical area and I strongly urge to you seeking competent outside assistance if you are financially challenged when it comes to interpreting your business's financial statements. When digging into your financials, here are a few key areas to run a "reality check" to see if you will need a more detailed audit of your books.
Remember, all you are trying to do at this point in the analysis is get a degree of confidence that your financials are accurate. If you even sense that they are distorted, get a qualified accountant in ASAP to reconstruct your financial statements!! Liquidity Ratios Assuming that your financials are accurate, you can now dig into a couple of simple ratios to determine the liquidity of your business. Liquidity ratios measure the amount of cash available to cover both current and long-term expenses. These ratios are especially important in keeping your business alive. If you run out of cash and your business is struggling, then chances are that the game will be over as it will be very difficult to raise more cash for your struggling business. Current Ratio Current Assets divided by Current Liabilities The generally accepted standard is a ratio of 2:1. This means that you have $2 of assets for every $1 of liabilities. A very low ratio means you will be having difficulty paying off your creditors and maintaining adequate cash flow in your business. It also means you are probably in the Zone of Insolvency and that is a very bad place to be! Acid Test or Quick Ratio The same as current ratio except it eliminates inventory so that only cash and accounts receivable are counted. If you want to be extra conservative when you run this calculation, reduce your receivables by some percentage (10-30% depending on your confidence in collecting them). Cash+Accounts Receivable divided by Current Liabilities A safe margin would be at least 1:1, or $1 of Cash & Accounts Receivable for every $1 of Current Liabilities. Working Capital Working capital is the money you must have to operate your business on a daily basis-to pay salaries and other bills. Working capital=current assets-current liabilities Any one of the previous calculations can give you more clarity into the liquidity of your business. Remember, liquidity is like the gas in your car's tank. When you are out of gas, everything stops!
Kauffman Business EKG (this link will take you to the EKG analysis) This is a free financial benchmarking service provided by the Ewing Marion Kauffman Foundation that is very impressive. I recommend you take a few minutes and enter your data (now that you have your financial statements in front of you) into their system. The Kauffman Business EKG provides a comprehensive assessment of your company’s financial vital signs. This is what their website states about the analysis: "You will discover insights about your company’s financial well being and how you compare to the “best of the class” in your industry. The assessment requires only a few minutes and will give you ideas and strategies for improving your company’s long-term financial health".
What are officers and directors responsibilities while in the Zone of Insolvency and how does operating in the Zone differ from business as usual? There is perhaps no other time when officers and directors are more concerned about personal liability for their decisions on behalf of a business, than when the business begins to experience financial problems. Officers and directors are accustomed to evaluating the best interest of the businesses' shareholders in their regular decision making process; however, once a corporation becomes insolvent, officers and directors must also consider the interests of creditors. If you have determined that your business is in the Zone of Insolvency and since I am not an attorney, I would strongly recommend that you seek competent legal council as this is very dangerous ground to be on. You can be held personally liable for your business decisions. Of particular concern is some thing called Fraudulent Conveyance of Assets. What does Fraudulent Conveyance of Assets mean? The illegal transfer of property to another party in order to defer, hinder or defraud creditors. In order to be found guilty of fraudulent conveyance, it must be proven that the accused's intention for transferring the property was to put it out of reach of a known creditor. If you are in the Zone of Insolvency you must be very careful in this area and, as already stated, I would highly recommend you consult an attorney if you are in the Zone. This can be a very tricky area and can land you in jail!!
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