Updated: Feb 7, 2022
Everyone is optimistic when they start their own business. After all, you have a new exciting endeavor ahead of you–what’s not to celebrate? While it’s always thrilling to pursue your passion, you must also financially start on the right foot. That means ensuring liquidity and properly managing your company to prevent business bankruptcy.
We get it–who wants to think about bankruptcy when you’re just beginning a new venture? And what does “liquidity” really mean?
Liquidity essentially refers to your ability to quickly sell your assets for cash without loss. This means you either have enough cash or since most businesses don’t have a lot of cash on hand, enough revenue or assets that you can sell to cover expenses if necessary.
You must be able to pay your bills and employees if you have them. Businesses generally face the threat of bankruptcy when they don’t have sufficient cash flow. You must be able to pay your bills and employees if you have them. Let’s review the four most common internal causes of bankruptcy and how you can prevent them.
4 Potential Causes of Business Bankruptcy
External factors can cause bankruptcy, which, unfortunately, are out of your control (e.g., natural disasters, politics, economic conditions, financial conditions, legal changes, etc.). Then there are internal issues, such as accounting practices, operations, and staffing.
So, what can you do to prepare your business for the worst? Start by focusing on the internal practices that you can control. In turn, you will ideally get your business to a point where it is successful and profitable enough to withstand even the external challenges.
1.Poor Accounting Practices
It may not surprise you to learn that a solid accounting foundation is pivotal to preventing business bankruptcy. Accounting mistakes that can cost entrepreneurs dearly include:
Not maintaining your books properly (e.g., not knowing how much you owe for taxes, applying for a business license, paying LLC dues, or getting proper permits)
Not paying your business taxes or bills (e.g., annual statement filings, state sales tax, quarterly taxes, property taxes)
Misclassifying employees (e.g., full-time vs. part-time or W-2 employees vs. 1099 contractors)
Mismanaging payroll taxes (e.g., Form 941, unemployment taxes)
Any of the above can lead to penalties and hefty fines for your company, causing irreparable damage. That’s why every business should have the proper people and accounting practices in place from Day 1.
You should understand what taxes, licenses, and permits you’re responsible for from the start. These are determined by a combination of what kind of business entity you have (e.g., sole proprietorship, partnership, LLC, S corporation, or C corporation) as well as state and federal laws. If you’re overwhelmed by all the bookkeeping and tax requirements, talk to an accountant who can guide you.
Bottom line: Know where your dollars are going and where they should be going.
2. Lack of Business Planning
Every successful business starts with a thorough business plan. Unfortunately, many small business owners skip this crucial step. They don’t bother figuring out how they’ll keep their organization going after the doors open. Businesses that go bankrupt due to a lack of planning typically:
Fail to budget (i.e., you have no profit, margin, and expense metrics)
Expand too quickly without sufficient funding and resources
Pile up debt (e.g., credit card debt)
As you can guess, all of these practices can lead to cash flow problems and eventually bankruptcy. Launching a business is–believe it or not–the easy part. But do you know how you’ll keep it running after opening day? How will you generate a profit so you can pay your bills, employees, and vendors? How long will it take you to be profitable at all?
Without business planning and budgeting, you won’t know how your business performs. You’ll have no insight into what areas are doing well and present more opportunities or which areas need improvement.
3. Employment Issues
Staffing is an essential part of any business plan. A staffing plan answers questions like:
How will you build your team?
What key positions do you need to fill to help your business succeed?
Will you hire employees, independent contractors, or a combination? (e.g., hiring an accounting team vs. outsourcing an accounting firm)
How will you manage each role and department?
What will employee training and development look like?
Not considering your team (or future team) can result in:
Insufficient staff: Let’s face it, you alone can’t manage every part of your business forever! But if you don’t invest in people with the right experience and qualifications, you’ll end up overwhelmed and overworked. Things will slip through the cracks–which can grow quite extensive and costly.
Loss of integral employees: Once you’ve built a team, the next step is good management. Ineffective management and poor workplace culture will drive away talent. Losing a top performer will cost you time and create inefficiencies. It could even cost you customers!
To take your business to new heights, you need to invest the time and money into a team that will help you grow. Without the necessary support, it will be challenging to build a profitable business. You could even end up losing money due to lack of growth, risking business bankruptcy.
4. Fraud & Theft
The unfortunate truth of being an employer is that occasionally, you’ll encounter fraud and theft from employees. Be sure to have policies and procedures in place to prevent and handle:
Expense fraud: From falsifying expenses to abusing the corporate credit card, expense fraud alone can occur in various ways. Check out our complete guide to expense fraud.
Time theft: This is often a more subtle yet equally severe problem. Employees might exaggerate their time worked or commit “buddy punching” (i.e., when an employee punches in/out for a coworker), just to name a couple.
Property theft: Then there is the most basic form of theft–when a worker steals cash, inventory, or equipment. From a few office supplies to valuable products, theft can quickly add up.
One way to prevent company fraud and theft is to ensure you have updated systems and technology. For example, invest in an automated time clock system and security system. Ensure your accounting processes don’t form a bottleneck–there should always be more than one layer of oversight. Every organization should also have:
Time and attendance policy
Theft and disciplinary action policies
A strategic business plan, team, accounting practices, and comprehensive policies are a solid first step to protecting your company. If you identify financial concerns, address them immediately before they reach emergency status. This could mean reassessing your budget or operations or working with an appropriate professional. Regardless of the issue, don’t let it fester to the point of business bankruptcy.
Do you have concerns or simply need help establishing an accounting and operational foundation? Schedule a free consultation with us today or call us at 603-505-2368 to learn how Check & Balance can help get your business off on the right financial foot!