Business Failures - Causes and Early Warning Signals


By

Prof. R.K. Gupta
BE Hons, MBA, FIE
Professor of Management & Consultant
Aravali Institute of Management
Jodhpur
E-mail:
rkgupta@rkgupta.in / cityju@rediffmail.com
 


Why Businesses fail

Business Failures are common and increasing and are nightmarish to stake holders, the owners and financiers. It is sheer wastage of scarce resources and many people loosing jobs.

Business typically takes three years to get well saddled (A Punjabi folk saying).

There is also a famous quote "Review your business every three years upside down"

What all that means? Well, you are beginning to become obsolete or weak even before you really get going into your business.

In fact the technology and competition (due to deregulation and mergers) in some sectors is changing so fast that three years are also a long period of time (for example, electronics telecommunications and computers).

The consumer behavior is changing rapidly with new generation now changing every 10 years as compared to 25 years, half a century ago. Today there are very few things common in preferences and lifestyle of a 15 year and a 25 year old.

Mega trends are sweeping not only American markets/society (by default), but across most of the countries aping the US and western lifestyle and products (Kotler Philip)

The start-up cost of businesses has gone up due to paucity of land in good location and consequential huge rentals and risks associated with businesses. For example, in retailing there is only one thing location, location and location (Kotler Philip).

Or take example of one wanting to set up a hotel. Where is the land within 15-20 kms of a Railway station or Airport available in any class A or Metro city? And if available, it is so expensive that it almost guarantees business failure within a couple of years.

The increasing salaries and wages of work force due to several complex reasons in which MNCs have a big role to play in countries like India. There is huge disparity in salaries being offered and local living costs. If we look at PPP (Purchasing power parity) basis for currency, the current salary almost doubles in India in real terms while compared to those in USA ( example In India Rs 20,000 are worth almost 35000 in USA.)

Too high salaries also distort economy and bring inflationary pressures thus reducing demand and vulnerability of Socio economic classes on lower end of pyramid (Prahlad, C K). These high salaries will reduce Indian competitiveness as gap narrows and that is what most MNCs would love to see.

Corruption and ever increasing costs of running governments also have crippling effect when such costs of bribery and unproductive functions of any organization run to as much as 25% of its profits or 15 % of its sales turnover as the case may be( A 1990 report of FIEO for exports).

As that was not enough, several factors in economics play their own part in pulling down shutters. Globalization has intensified competition to almost killing level in many industries (But not for all, as is widely written and believed by academicians and the so called business experts and economists). So it depends on, in which industry you are operating.

Not all industries are amenable to mass scale of economies and have fundamental protection of manual processes, for example cycle tyres and tubes of cycles or candles or high grade up-market fashion wear. More automated and larger is the business, more vulnerable it is to competition, obsolescence and supply chain management problems and weak links therein. It is very different to operate locally and expanding to county level and the in global markets. It needs major shift in policies and organizational dynamics. There is acute crisis of really effective leaders (not the one having fancy degrees and diplomas from premier colleges)

Legal environment also playing its role- like consumer laws, increasing role of NGOs, environmental protection laws and need for social accountability.

The most difficult to manage marketing network today with complex channel arrangements available and acute shortage of display space in stores and dearth of distributors. The marketing costs cripple small businesses, anyway. Cash flow management and credit recovery is very poor in India due to poor laws and instability in economic factors.

Role of CEOs/Owners

To top it all, the entrepreneurial weakness is one of major reason for failure of businesses including SMEs and also large enterprises. The quality of leadership and commitment to declared mission and policies are important, but are hardly maintained.

I have seen several Indian companies loosening up their processes and quality as time rolls by and business starts picking up. It is probably human nature to get illusions of success and safety once the business starts rolling and so business process parameters are relaxed and expenditures are cut. The CEOs forget that there is a time lapse between introducing or abandoning a good factor of production or a good employee and its effect on business results. It may run to a few years even for very large organizations. But reverse counting starts which arrogance of quick success blocks being noticed by those at helm of affairs.

May be that is why the above mentioned quote of reviewing your business thoroughly  every three years,  becomes more relevant,  in present day context.

Many attempts have been made by scholars and financial organizations to analyze why businesses fail and can us predict impending failure in terms of developing forecasting models and identify early warning signals of business failures.

Anyway the stakeholders are all interested to know that- The investors like share holders, venture capitalists, financial institutions and the employees and some times customers too.

Of course promoters are the most concerned but often most of them are ignorant about early warning signs as short term success is assumed to be infallibility of their business model and capability. This is sadly proven wrong in large number of cases world wide and not only in India.

Indian entrepreneurs have to get out of this arrogance and complacence factor that makes them overlook the environmental and internal changes and laxity developed in employees and in critical business processes that are directly linked to consumer/customer satisfaction

This paper attempts to document the experience of the author as a senior executive in Indian industry for almost 28 years working across several important sectors and in public and private organizations, both. The author had privilege to regularly interact with more than 3000 customer and vendor organizations in India besides plethora of peripheral organizations like advertising agencies, financial institutions, and service providers. The author having worked for some time in a leading state Financial institution in period 1981 to 1983 saw several changes coming and having appraised more than 50 industrial proposals and analyzing rehabilitation plans for several sick units in small and medium sector had opportunity to get first hand experience of working of these units and their weaknesses and causes of failures.

The major weaknesses of businesses can be classified as below:

Entrepreneurial:

1. Untrained (non professional) and in experienced entrepreneurs in particular trade.
2. Trading entrepreneurs entering manufacturing sector and now in services sector
3. Greed and Profiteering- Immediate profits and narrow vision.
4. Unwillingness to buy technology and pay to skilled loyal workers. Poor HR functions.
5. Over growth or hasty growth without building systems and organization with committed, trained and motivated work force (both at worker level and at managerial level). I have seen many businesses fail when entrepreneurs tried to grow in size significantly and abruptly without gaining experience and adequate resources or capability, graduating from an SME to large or from a small to medium sized operations. Particularly Human resource and Marketing network are areas where they failed miserably.

Structural weaknesses:

1. Too small or too large capacity that is not right for a 3-5 years period horizon, only.
2. Poor marketing network (By far the most difficult to develop – especially for SMEs).Most SMEs are puppets in hands of major distributors in the network.
3. Wrong location causing dearth of good employees and/or raw material or logistics support and thus increased cost of  product and processes and training and development charges.
4. Over financing by debt or over capitalization  for long term assets, or lack of working capital ( due to several reasons like poor credit management) or both
5. Poor technology that is already obsolete or not likely to be competitive in next 3-5 years period horizon.
6. Poor quality and completely lacking management systems including lack of delegation.
7. Poor internal employee training and development program and failure to involve employees, particularly in services sector. Failure to involve them emotionally and create motivation.
8. Lack of innovation culture in organization with customer need in focus.
9. Lack of up gradation, modernization and introduction of new products and services regularly.
10. Poor attitude towards consumer/customer  and their needs and complaints (A major problem with Indian  customer care executives and owners alike)
11. Lack of industry and regulatory norms being followed. In India particularly entrepreneurs tend to overlook norms and regulations fixed for business derisively and contemptuously. This leads to wastage, poor productivity and poor quality.
12. Unstable source of raw materials and its quality at Globally  competitive prices)
13.  Failure to create Brand/ Brand experience or piggybacking on other brands far too much (More brands are dieing today than created).
14. Relaxing standards or cutting costs under illusion of having arrived (success) by new businesses. It is only matter of time before competition and consumers catch you on wrong and weak foot.
15. Lack of Documented and well laid out policy and procedure manuals with quality check points. High rejection rates or poor products result that consumers don't value. Remember consumer buys till she has no option. It is not consumer loyalty. Consumer is loyal to no one for a few Cents off ( Kotler, Philip)

External (environmental) factors:

1. Non availability of logistics chain and too high cost of distribution (particularly in traditional channels) Hybrid channels are in thing with web sites and emails as important channel. ( Ignoring this will result loss of business to many good firms)
2. Too high cost of interaction with government and regulatory agencies (India- almost 10% -15% of  sales turnover)
3. Poor industrial and logistic infrastructure and lack of modern facilities for shipment and handling.
4. Global competition tending to make products obsolete and tending to push prices down( particularly those made in countries like China, Taiwan, Korea, Mexico, and such countries)
5. Poor labor productivity in India on account of several complex reasons
6. Rising costs of doing business. High economic rents demanded by all.
7. Mergers and Acquisitions making competition and capabilities unfair to the firm.
8. Political interventions and political instability
9. High interest rates and cost of raising capital
10. Poor Industry ROI
11. Product of organization moving down the product Life cycle, if one applies.
12. Exchange rate fluctuations or weak domestic currency or wide arbitrage gaps in foreign currency markets.
13. Educated and aware consumers with internet technology driving his/her factual knowledge about product and its availability and alternate channels of supply.
14 High taxation in India with poor infrastructure and delayed deliveries will result in markets flooded by cheaper and well made goods like from China.
15 New models are being thrust on market post WTO opening like organized retails, Malls and Multiplexes making traditional shop going out of business. Volumes and comfort will matter except for daily necessities purchases from corner shop.

It is thus summarized that all business organizations must have:

1. Critical success factors (like say placement and high quality faculty pool are such factors for a management institute) and,
2. Critical Business processes, both of which, they are supposed not to ignore and preserve religiously. If these are missing, the business is bound to die sooner or later but not later than 5-7 years in current situation, however big the business may be.
3. Fundamental strength or USP for the business organization or the product is passing through a boom phase due to favorable business cycle in its consumer sector, like in case of cement currently for real estate and infrastructure industry.
4. Well developed numbers of loyal and significant buyers or consumers (mostly in Institutional or Capital equipment marketing) but now in consumer products also. Customer retention will be challenge. This is different from routine brand switching (Markov Chain model)
5. Industry has limited new product substitutes in sight or has high entry barrier or regulated by domestic laws or cost (Porter)

If any of above is missing, the business failure may be round the corner but may not be visible.

The current markets conditions will not absorb the producer's inefficiency and high cost of investment and operations excepting for monopolistic conditions or location advantage like in retailing, for example, a fast food restaurant in a prime market or a Mall in a big city. The failure factors are therefore business size, nature, location and target market specific. They are also today increasingly technology specific.

Those organizations that fail to pay attention to consumer relationship building, consumer delight, Quick response to purchase calls and complaints and closing of sales, product innovation, and consumer designed products (product flexibility like in case of DELL computers) and employee development and retention are sure moving towards failure.

Even those big stores that have location as advantage are being plagued by new factors like parking problems, peripheral urbanization in cities in new settlements and tendency of  families to move out to sub urban areas. The online shopping (e-commerce) tools, virtual stores and home delivery will give run for money to traditional and badly managed businesses even in retailing (see huge success of ebay).

Your business model should have distinct advantage visible to prospective consumer in terms of functionality, quality, aesthetics, cost advantage or reliability and future up gradations and assurance of good and prompt service. (Most Indian organizations don't invest in a quick, complete and satisfying after sales service or warranty service). This model can only be replaced by a throw away type cheap but highly standardized product design (Casio digital diaries for example). Even, Windows (Microsoft) upgrades its software free and periodically up to certain number of years. Businesses must attempt to create customer delight and repeat purchase.

Same way every business has got to get expanding continuously to take care of growing needs of  employees, their rising wages and welfare allowances (some are statutory) driven by competition pressures and to imbibe bombardment of newer equipment and technology, all the time (Kaizen and lean manufacturing system of the Japanese, for example).

It is unfortunate that in countries like India very few organizations (entrepreneurs) pay attention to above factors and get complacent after initial years of success when the business is anyway moving in 'high growth/maturity stage'.

While financial ratio analysis can be good indicator of historical data, they miss the future environmental factor changes and changes in capability of competitors, regulatory bodies and organizations themselves vis-ŕ-vis changing competitiveness in market place and investments. Businesses will have to fight with virtual marketing networks, 'drop shipping' system and outsourced component/product assembling units. Major decisions regarding nature of internal manufacturing vis-ŕ-vis cost and reliability are vital.

The midi-corps will get together and give tough fight to mega-corps and no buyer will need a third supplier in highly integrated ERP based procurement system and six-sigma and DOL (Direct on line delivery) quality models used (Mak Henon ;1990 in Tomorrow's Competition, AMA Publication NY)

Unless the product is in Commodity category like common salt, product innovation plays vital role in its continuous viability and keeping customer excitement alive.

Having surveyed the basic factors for business success and failures, we turn our study towards analysis of causes, forecasting possibilities and early warning signals of business failures:

Some Studies on causes of Business failures

In a Report on Small Business in the Cover Story: Black Enterprise, Nov, 1996  by Tonia Shakespeare some indicators are given: (comments added) Author writes:

* Cash flow problems: "When your company is financing with debt as opposed to equity, your business is headed for trouble (despite theories of  financial leveraging). And if it takes you a long time to collect debts from customers, and if your expenses are increasing while your sales are decreasing, your company is sure at risk," If business has started defaulting in payment to vendors and employees, these are sure signs of impending disaster in terms of high cost of purchase, employees leaving organization and poor quality of inputs creating a vicious circle.

* Growing too quickly: Every business owner wants to grow his or her business, but expanding with no infrastructure in place makes a business ripe for failure. Taking employees and their capabilities for granted is a part of this illusion. Many owners think initial short term success in boom phase of business cycle is continued gurantee of customers pouring in. Many business fail simply as there is no committed human rsource available for quick growth. New faces of employees are not very much liked by customers in service sectors.

* Losing focus : Business owners often fail when they lose focus. They stray away from their core product or service or become too dependent on ancillary products.

Your customers patronize your business because of your primary product.

* Loss of customers: Adding customers wont help if there is lekage in bottom of tub.Pay heed to increased customer complaints and decreased customer traffic. Disgruntled, fleeing customers could be costing your company lacs of Rupees  in lost revenues every year. Most businesses take customers for granted and even refuse to reply or acknowledge or simply ignore them because they have poor investment in customer care component of business ( India it is very serious) and professional courtesy.

* Not knowing your limitations. Most business owners assume they know their limitations. They either fail to recognize their deficiencies or choose to ignore them. Thinking you have more talents than you actually possess, and not hiring the right people to shore up the areas where you are weak, will send any business spiraling down. It is seen that many bosses prefer to work with poorly qualified and inexperienced sycophants and yes-men type employees rather than based on merits and competence. Their downfall is inevitable in due course of time.

I would like to add here the important factor : Failure of business to acquire significant number of new customers and new markets segments refusing to accept product offering of business. New equations fail to work out.

In another study ,having witnessed entrepreneurs in various stages of distress, Coopers & Lybrand's Jacalyn Goforth offered 12 "red flags" of potential business failure

1
. Are you having difficulty meeting your bills? 2. Are you experiencing a shrinking market for your product?
3 . Are you frequently losing customer sales? 4. Is there an increase in customer complaints, revealing that your business is failing to meet their needs? 5. Do you find that inventory levels are climbing faster than sales, and you are building up more inventory than sales warrant? 6. Is your company highly leveraged and thinly capitalized? Does your bank have more at stake in your business than you do? 7. Do you have essentially a one-person management team? Or one man show? Ask yourself, is my company over dependent upon any one person? 8. Is your business suffering from poor management communications? Are decisions not being disseminated down from the top? 9. Are you working with poor management tools (that is, are you getting inadequate information on sales levels, growth in accounts receivables, inventory levels, etc.)? 10. Is your company very late in producing financial statements? This is a sure sign of poor financial planning. 11. Are you experiencing sales growth but no growth in net income? 12. Do you have a tight grip on expenditures, or is your company committing to expenditures before cash is in hand?

These are simple and  logical points to ponder.

In yet another study , 15 signs of failing reputation of company are indicated (Zeryn, Inc, © 2007 ) (Modified at few places):

1. There is low employee morale
2. Internal politics are more important than doing the job well ( Major problem in India)
3. Top or key executives depart
4. CEO celebrity displaces CEO credibility ( a fragile condition of business)
5. Employees speak of customers as nuisances
6. Employees stop telling positive stories about the company
7. Leaders stifle initiative
8. Leaders talk about growth but focus on cost-cutting
9. Bureaucratic procedures impede flexibility
10. There is a tendency toward superficiality
11. Problem-makers outnumber problem-solvers
12. Internal documents leak
13. There are few rewards and recognition
14. Management spends more time inside than outside headquarters
15. Employees spend too much time writing internal memos
(Author: unknown)

The nightmare scenario keeps many business owners awake at night! Consequently, for many the main objective set at the beginning of each month is to earn enough money and have sufficient cash in the bank to pay the staff and the bills that are due. This constant pressure can, quite understandably, make people "crisis-manage " most situations or adopt 'reactive management'. Although this is a very good way to solve short-term problems, it can make a business owner miss some early warning signs of the fundamental causes of business failure. These every-day issues can be symptoms of some deeper fundamental problems with the business that if not addressed, can cause a business to fail. It is also seen by me that very few businesses implement projects carefully with first class engineering, Project management and with help of experienced  engineering managers thus in-buidling birth defects that may take too long to cure or simply cause death of busines in due course as more and more money is wasted to remove structural defects in projects. Many Indian entrepreneurs are unwilling to appreciate value of knowledge and experts and intangibles like Right technology or manufacturing and distribution processes( 30 minute Pizza delivery of Domino)

Some examples of problems that occur are: 

Early Warning Sign

The Problem

Sales are unpredictable and irregular.

How you acquire customers is more due to luck than design or effort. You fail to attract target customers or market segments.

Not many customers place a repeat order and very few new customers are from 'word of mouth' recommendations.

If you cannot keep your customers or generate favorable word of mouth then it is probably a sign that either your product is not up to scratch or your company fails to live up to its promises.

Prices and profit margins are being squeezed down.

Your market is getting more competitive, and your product is failing to hold its value. Your customers are starting to believe they can get better products elsewhere. If you let your mark-up fall below 100% then you are becoming reliant on creditors to fund your next job.

Sales are falling.

You or your market is in decline. You and your service are either not as good as they were/or promised, or your customers' needs and desires are changing so that they no longer require your services (obsolescence or substitutes)

You're always fire-fighting! No time to think.

You are reacting to problems rather than proactively seeking to solve them. Your management skills or resources need improving.

Delaying decisions and letting others decide.

Recurrent doubt has set in. The more you think about a problem the less confidence you have in your own abilities to solve it. It then becomes more appealing to let events or others make your mind up for you.

Large cash flow fluctuations.

Your financial management skills or systems are not up to scratch.

Large cash flow surprises. Sometimes your cheques bounce or you can't pay a bill when required.

You do not know on a day-to-day basis how much cash you have in the bank. You are making business decisions without considering or knowing whether you can afford them.

No capital reserves.

You are probably either under-capitalized or trading unprofitably.

Staff retention is poor.

People lack belief in the company or in you. Your people management skills and recruitment practices need improvement. Or you underpay competent employees or deal unfairly.

The atmosphere at work is always tense. You hate your business and start to spend more time away.

You are secretly hoping that the business will fail and you will be relieved from the burden of running the business.

Excuse culture.

You have accepted defeat. No one is responsible, it's everybody else's fault, and nothing can be done!

Always focusing on the rosy future, never the problematic present.

You can't cope with things as they are and you console yourself by hoping for improvements tomorrow.


All of the above are early warning signs of underlying problems that are not being addressed. (Courtesy : Camden Council)

An increase in customer complaints, indicating customer service problems that could ultimately lead to a loss of business are ignored. Again, this could be due to under-staffing (Indians owners have this mentality), poor quality control, or a lack of strategic planning by the owners. The concept of HRM are ignored by not making due provisions for casualties, sudden resignations, normal employee turnover and leaves.

The only way one can reduce employees is by automation and Multi role training and motivation of employees. In country like India concepts practices by MNCs of slim organisations don't work well as employees lack professionalism and work culture, still attached to their rural backyards and emotional tie ups in complex family systems. Countries like India have tremendous movement of internal migratory workers that are ill trained, unstable and poorly paid. Most of business failures thus come from lack of stable and trained work force and competent and experienced executives.  Indian owners and CEOs are de facto not willing to delegate thus limiting supervision quality and becoming captives of their own circumstances. It becomes circuitous eventually.

Lack of training and a slowdown in skills provision among staff is another reason. Owners often start cutting training programs (internal and external) because they believe it is a cost that can be removed without actually damaging a business. If staff doesn't have the relevant skills the end result will be that the business will suffer. Poor salesmen (Uninformed, lacking product knowledge, courtesy, commitment and aggressive follow up), discourteous and trained front desk officers and poor trouble shooters may destroy your business faster than you think.

How you react when a customer is unwilling to recommend your company or solution is a strong predictor of the longevity and success of your business. Why? Because what is preventing customers from speaking on your behalf is likely also making them hesitant to repurchase, to use your solutions effectively, or to list your company as a preferred vendor. Do you take the "ignore it and the problem will disappear" route? Do you put the blame on marketing or the policies of your customers themselves? If so, don't expect a long, healthy business life.

Project delays are perennial problems in countries like India causing failure of businesses. There are several reasons to these delays and are not discussed here in. Badly started and managed projects are often predictor of failure. Both the customers and employees have social, psychological and security needs which are often neglected by business organisations and lead to failure.

Benchmarking

I would like to add that every business should benchmark themselves  with atleast one equal size rival and one Industry leader organization( from top 5 in industry, globally if that is your business domain) for various  Norms, Critical success factors and productivity ratios like, say, specific consumption of power, specific input of raw material and rejection rates for various factors identified as above and the norms and standards available for the Industry products and processes from the quality enforcement and development bodies/ Associations/councils.

Remember you may not believe in those parameters but your many competitors may believe and act . Do you provide the state of the art resources to the employees and customers?

Most important is religious commitment to maintaining critical and good business processes and quality standards and not relax them in any circumstances. That is where most failures come from. And that is on which many companies avoided collapse. Customers only stand by quality and committed brands and suppliers.

The above discussions with some alterations also apply to various services sector units with more inputs on front desk management and emotional experience of customers in utilising services, billing systems and  fast service using technology.

Predicting failures through models

Though several mathematical tools have been attempted to forecast insolvency and business failures, it is only a qualitative matter to be carefully considered from business to business and industry to industry based on their critical factors of success or shall we say survival . For example , in Predicting Corporate Failure: Empirical Evidence for the UK, Andreas Charitou et al ( University of Cyprus), observed that "The results indicate that a parsimonious model that includes three financial variables, a cash flow, a profitability and a financial leverage variable, yielded an overall correct classification accuracy of 83% one year prior to the failure. In summary, our models can be used to assist investors, creditors, managers, auditors and regulatory agencies in the UK to predict the probability of business failure". The importance of cash flow management is thus vital factor in business failure.

In yet another attempt, "Predicting the survival or failure of click-and-mortar corporations", Indranil Bose; Pal, R. Hong Kong Univ., China (March 2005); observe: "With the boom in e-business, several corporations have emerged in the late nineties that have primarily conducted their business through the Internet and the Web. They have come to be known as the dotcoms or click-and-mortar corporations. The success of these companies has been short lived and many of these companies have failed rapidly in a short span of 4-5 years. This research is an investigation of the burst of the dotcom bubble from a financial perspective. Data from the financial statements of several survived and failed dotcom companies is used to compute financial ratios, which are analyzed using two data mining techniques - Discriminant analysis (DA) and Neural Networks (NN) to find out whether they can predict the financial fate of companies. Neural networks perform better than Discriminant analysis in predicting survival or failure of click-and-mortar corporations. The key financial ratios were identified by them in this study".

In an empirical study "Using Linear Programming to Predict Business Failure-
An Empirical Study: by Jan Wallin and Stefan Sundgren (1995) it was summarized as follows:

" The purpose of this study has been to test whether mathematical programming performs as well as logistic regression when the task is to predict bankruptcy. In the empirical test carried out here on a large holdout sample (78 failed firms, 922 non-failed firms), the mathematical programming function performed better than the 'logit' model both for failed firms and for non-failed firms, confirming our hypothesis that mathematical programming performs at least as well as logistic regression in terms of ability to predict bankruptcy".

In yet another research paper, "Scores - a guide to failure prediction business failure (Auditing)" by Eidleman, Gregory J. The CPA Journal online 1995, the author claims that:

"The incidence of business failure in the US is increasing. Statistics show that more than 300 companies go out of business every week. The high rate of bankruptcy is attributed to the combined effect of fiercer competition in the marketplace and heavier debt burdens carried by companies. Matters grow even worse when these two factors are accompanied by an economic downturn. A company's chances of survival can be predicted with the use of financial-statement analysis. One of the most commonly used statistical ratio models for predicting business collapse is Altman's Z score. This model has proven to be a reliable tool for bankruptcy forecasting in a wide variety of contexts and markets. However, it should be noted that the Z score does not apply to every situation. It can only be used for forecasting if the company being analyzed can be compared to the database."

"Models often do not give a clear result. Whenever there is doubt, we must look to the intangibles and address the qualitative issues.

    • Most users lack an adequate database to construct their own models. As a result, they must purchase a custom-built one (expensive) or rely on models like those described here that may not meet their specifications exactly.
    • Whether Z scores and the rest can out-perform traditional approaches is a question we can only answer in the real world. In my opinion they are a valuable, cost-effective weapon to be added to the arsenal. Provided they are used to complement our existing knowledge and we are not fooled by their apparent exactness, they can only improve the quality of our work."

Most of the above studies are thus attempts to use historical data and samples of companies and using statistical tools to predict causes of failures.

Unfortunately the causes are not merely financial vulnerability or mismanagement but they are also embedded in CEOs style of working, policies and structural defects in business processes and project itself.

Below is given a link of one 'online tool' for 'Simple ways to assess the profitability of your businesses". It is interactive tool that examines financial criteria amongst others.

http://www.insolvencyhelpline.co.uk/interactive-tools/interactive-tools-main.htm

One method of predicting business failure is by dividing the company's problems into three separate areas–{Courtesy ' The UK insolvency helpline'}:

    1. The defects of the Company

      1. Bossy or single minded managers and directors
      2. Idle or lazy management
      3. Lack of financial controls such as budgets or cash flow forecasts
      4. Not comparing actual results to expected results (Variance analysis)
      5. Poor communication with/between management members
      6. Lack of control over book debt collection

    2. The mistakes of the Company

      1. Expanding the operations of the company without sufficient funding in place
      2. Relying too much on the overdrafts
      3. High borrowings such as loan commitments
      4. Bad/lack of planning leading to the failure of certain operations
      5. Getting involved in long and expensive legal battles
      6. Allowing certain customers access to extended credit lines
      7. Irresponsible purchasing of goods and materials
      8. Heavy reliance on large customers
      9. Late payment of crown(State) taxes

    3. The signs of business failure

      1. Diminishing bank accounts
      2. Hiding or ignoring problems
      3. Falling product or service quality
      4. Lack of specialist staffing
      5. A lack of a predictive business plan
      6. CCJs, Statutory demands and threats of legal action
      7. Poor or lack of communication with the banks

Most business failures can be avoided by thinking about the consequences of the above scenarios. The problem is that most managers neglect all the signals of failure hoping that they can trade out of adverse situations. The most common scenario is that businesses continue to trade until one creditor suddenly asks for immediate payment and the company realizes it may be insolvent.

Conclusions

I have seen many businesses fail in India because of wrong locations, too fast growth without advance organisational planning and capital provisioning, inability to market  large quantities of products and poor credit recovery from marketing network. It gets business into vicious circle. Poor cash flow management  and thin margins available to SMEs in competitive markets depending on distribution network are some important reasons for failure.These can be watched and monitored.

One area- Marketing Muscle ( Innovations, distribution network, logistics, goodwill and Brand equity) is not easy to develop quickly for most of organizations in world , however large or small they may be and how so ever competent the CEO and their senior executives may be.

It needs continued commitment of CEOs and senior management as well as identification of points of vulnerability and first of all admitting them and then embarking on corrections. If it is not possible, just get the hell out of your business as fast as you can before no one is willing to buy it anymore or merge with it.

In short if your ROI is less than 25% or you have employee turnover rate more than 15 % or your labor costs are more than 10-30% of total cost of production depending on type of industry from highly automated to manual process industry or service organization( 30 to 50%), you already have early warning indicators for failures. Not only a core band of loyal customers is required (through CRM practices) but new markets and customers have to be added. The firm must have one or more critical success factors working to its advantage and to protect it against volatility and competition-Like better technology or better network or a strong brand or the product design and delivery network.

The world class organizations that attempt to remain in forefront of technology breakthroughs, high value additions, product variety, on time delivery and competitive prices are hard to kill. They often are companies having polite and aggressive front desk employees and sales persons with quick customer support. (In India even a little success of an organization makes Executives loose courtesy, response and communication)

The companies, which keep customers all the time excited about products and render world class after sales service or customer care, keep doing well. Such companies don't have financial ratio problems and thus render use of mathematical tools irrelevant for prediction of failure.

Quoting Dr. Leslie Gaines-Ross, Burson-Marsteller's chief knowledge & research officer worldwide: "Great reputations are neither built overnight nor the result of good luck," he said.

"They are carefully planned, nurtured and managed as the vital assets they are. Likewise, reputations are not always destroyed by one adverse event, but often erode gradually."

I have seen very closely that indecisive, over cost cutting and non committed owners are often main cause of failures as they don't stick to business processes quality and product delivery as per customer needs. Many of them pay little respect and attention to Human resource and its value.

Bigger the ship, it takes more time to go down .The captain should not have complacence that it won't drown anyway. It will, if it gets weak and leaking, or the storms and waves of competition and technology, just sweep over it.

Acknowledgements

This article is an attempt to bring together various studies to analyze causes of business failures and also briefly mentions about use of statistical models tried  to predict failures. The matter has been compiled from various sources and duly acknowledged at appropriate places. The major input to the article is author's own experience in managing and promoting businesses in medium and large–medium sectors in India, for over last 30 years.
 


Prof. R.K. Gupta
BE Hons, MBA, FIE
Professor of Management & Consultant
Aravali Institute of Management
Jodhpur
E-mail:
rkgupta@rkgupta.in / cityju@rediffmail.com
 

Source: E-mail July 5, 2007

        

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