Chapter II. Why Businesses Fail

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II. Why Businesses Fail

A. Th ree Main Reasons for Business Failure

1. Bad Management

Poorly managed companies tend to manage their vendor relationships the same way: poorly. Poorly managed companies also tend to be undercapitalized and, as a result, rely on trade credit to finance their cash flow.

2. Bad Decisions

A well-managed company can still suffer from a bad decision by management. This is especially true in the consumer products supply chain. A poor decision regarding style changes, seasonal demand or technology changes can be disastrous. Even a well-capitalized company can quickly become troubled following a poor decision by management. The recent troubles in the retail industry are a perfect example of this.

3. Bad Economy

Most business are susceptible to bad economic conditions. Creditors often contribute, quite unwittingly, to a financially challenged company's problems. Poor credit analysis and lax collection practices often contribute to the bad business habits of customers. Financially challenged companies live by the old adage, "Give them an inch, and they will take a mile." Thorough credit analysis, coupled with adequate monitoring of customers, is necessary to maximize your chances of recovery.

B. The Warning Signs

Customers do not fail overnight. They slide into insolvency over a period of months and even years. Most companies in financial decline exhibit one or more warning signs. Creditors that are diligent can recognize these warning signs and take action while there is still time for credit enhancement or credit protection. On the other hand, creditors that don't recognize these signs could be in trouble.

1. Accounts Receivable Aging

Slow-paying customers are a problem. But slowing paying customers are a bigger problem. If your receivable aging for a particular customer shows a trend of slower and slower payments, that customer's cash-flow problems could be mounting. This is usually the first sign of trouble you will see.

2. Increasing Leverage

All companies have some level of debt. But a steady increase in leverage from non-equity sources can be a sign of trouble. Financially challenged companies often try to finance their way out of trouble by taking on more debt, either through ever-larger credit facilities, bonds and notes, and lease financing. If a customer's leverage...

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