Have loans? Reasons that can lead a small business to bankruptcy
Various events and the manner in which a business is run can lead to its bankruptcy. If you have creditors, it is particularly important to understand some of the key reasons that often lead to a business going bankrupt.
No grip on expenses – It is the most elementary of all financial lessons that you need to be careful about your expenses. This is particularly true if you have a loan and have monthly repayments to make. However, it is
often seen that with cash in the bank after a loan is sanctioned, many small businesses tend to get lax about their expenses. A loan should never be used to fund profligacy or unnecessary expenses. A loan has to be repaid and it comes with interest. It is very important to have a good grip on your expenses and be frugal about running the business.
Incorrect projections – Every business has a set or projections and does some forecasting. Based on a number of variables, a business comes up with an assumption about how the business would do in the future. For example, if you are taking a business loan to increase your production capacity, you would need to submit a detailed business plan to a bank. However, if your projection on capacity utilization is faulty you would have wasted money on expansion and would now have to pay ..interest on the loan you have taken. Projections that are incorrect and based on faulty parameters can quickly lead a business to some serious financial crisis and hence one should carefully assess every set of business plan and projection.
Business environment – As pointed out in this article, economic disruption along with innovation has meant the average lifespan of companies has dramatically come down. small businesses run a much bigger risk. A saturated market, competition and economic upheavals pose serious financial risk. Although, it is tough to plan for the uncertainty, small businesses in the country have to do a much better job in looking of for such large scale disruptions. At the moment a large number of small businesses do not seem to have an eye out on the changes taking place around them, which in turn can put at stake their very existence
Inability to secure new capital – There may be times when your business may need a fresh round of capital raising to sustain. It can also be to get over a temporary shortfall of cash. Fresh capital can flow into a business through an equity stake sale or through debt. However, unfavorable economic conditions or the situation of your business may be such that you find it difficult to raise new capital. In the aftermath of the global financial crisis, many small businesses found it extremely difficult to raise capital, eventually leading to their closure.
Taxes, penalties, fees – Taxes are a part of every business, but if you have made incorrect provisioning or filing, the resultant payment that you have to make may have serious implications. Penalties on the other hand can be unexpected, but can cause serious problems when penal charges are levied for being on the wrong side of the law. For small businesses, risks around taxes, penalties and fees are significant and hence all legal provisions should be assiduously followed.
Cash flow – If there is a problem with your cash flow, which is the amount of cash coming into your business is less than what is going out, it is going to be a recipe for trouble. For example, you may have executed a lot of projects by borrowing from creditors, but it is taking forever for you to receive the payment for the work done, the business is going to be in trouble. This is especially true with the new bankruptcy code where anyone can file for bankruptcy of the business ..
Keep a close watch on cash flow, which ideally should happen through a cash flow budget that you look at every day.