The Road to Bankruptcy
The story owners tell is usually the same: sales slowed, a customer paid late, and then the bills started to pile up. Then, suddenly they couldn’t make payroll. Often, no one at the helm took a truly foolish risk. There is usually more than one way to bankruptcy, but the road to bankruptcy is laid down with the same stones.
Between 2006 and 2010, more than 208,000 companies filed for bankruptcy, according to the American Bankruptcy Institute, and the annual rate nearly tripled over that period. Those numbers don’t even include companies that went bankrupt but didn’t file. Nor do they count companies that merely stumbled: getting in over their heads but still solvent, and struggling to pay the lights or make payroll. Many of these companies could have avoided bankruptcy with some simple changes in their businesses and with better management of their cash flow. What usually sinks them is that the owners ignored a handful of basic principles. When the world is in turmoil, it’s even more important to grasp the basic fundamentals.
Basic Principles
The first is a current business plan that you are committed to. Most companies with plans have them sitting on a shelf somewhere. A real plan has a sales and marketing plan, an operating plan, a capital-expense budget and a cash-flow projection. It is used to define expectations and goals and tie them to the team. And this business plan is reviewed regularly, and compared to the actual results. Did the revenue come where it was expected? If the market is stronger than predicted or weaker than expected, it is important to reset the forecasts. It is not the responsibility of the owner or CEO alone to keep the plan updated.
The second is cash. Having cash flow and being profitable are two entirely different things. No one is spending time worrying about the income statement when the debt is due and there’s not enough cash to cover it.
The goal, at a minimum, is equilibrium: making sure the cash going out does not exceed the cash coming in. That is not hard to do, but it is a discipline and not always the focus. In a shaky economy it is common to see big swings in sales from one month to the next, which means some months more goes out than comes in. So if you don’t have enough coming in in January to pay the bills in February, you better have enough extra in January to cover what you are not making in February. Profit is an accounting concept, but if cash flow goes negative, it’s real and eventually it will kill you. You need a constantly updated forecast.
The third principle is about your books. Your accounting records and process should be as reliable as the clock. You need to know where you are. Missed journal entries, wrong accruals and totals that don’t add up should be caught by you, not by your banker, partner or investor. You’ve got to do more than just verify that things balance, of course. Before anything goes out, always test the facts behind the numbers and assume nothing. There is an element of fear involved in seeing how the company is doing, but you can’t be afraid to look the numbers in the face.
The fourth principle is to stop protecting sacred cows. Every company has cows that were once important, but now have drifted in importance over time. New employees come in and see them and think they are mandatory. “We’ve always done it that way” is not a good enough reason when performance has to improve. Probably everyone in your company has a pet project and perhaps they hold on to it longer than it makes good financial sense. Or maybe there are people and jobs that no longer make sense, but you’re afraid to cut them loose. Nobody wants to make these decisions. But protecting sacred cows can be very tempting, and very costly.
The fifth principle concerns your lenders, particularly secured and senior creditors. When results turn bad, the temptation is simple: If the numbers are atrocious, hide them. Take another shot at the “perfect” report. Don’t send it. Wait until the crisis has subsided. None of this will help your situation. Reports to creditors need to be timely, transparent and precise. Don’t go out there and sugarcoat your financial situation. If your numbers are bad, share them honestly. Once the actual results come out, a creditor who was kept in the dark may never fully trust you again. When lenders do not trust the borrower, they tend to be much harder on them when problems arise. Work on creating the relationship that you need from your lender by being an open book. Your relationship is valuable. But it has to be earned.
The sixth principle is honesty, and it starts with being honest with yourself. There’s a tendency to avoid dealing with the dirty details because it is uncomfortable. A lot of owners have a bag full of tricks to stay afloat in a crisis, and it is easy for them to keep borrowing the next month or asking the bank for extensions and saying they will make it better next time. It is an illusion, but everyone wants to believe in it. Consistent declarations of forthcoming improvements create the illusion of impending relief, which can lead team members to discount the gravity of the situation. The sooner you are able to admit to yourself that the company is in trouble, the sooner you can start fixing it. There is no point in playing out a drama you already know how will end. No one wants to hear bad news, but it is always better to tell the truth.
The seventh principle is knowing when to ask for help. A lot of times a crisis hits and the temptation is to try to tackle it alone. Trying to solve every problem inside your company is a major mistake. A lot of owners will go to great lengths to avoid the embarrassment of declaring a crisis and asking for the advice they know they need. One of the big issues that afflicts a struggling company is pride. No one is ever in control of all aspects of their company, and keeping up with every change in finance, markets and people while running your own business is close to impossible. When you are in trouble, there is no shame in asking for help. There are people who know more about how to fix the problem than you do. The advice of knowledgeable, experienced outside specialists can sometimes decide whether a company survives. It will take some courage to admit that someone else can do it better, but in many cases that’s exactly what you need.
None of this is new. These are the rules that experienced business owners know, but they are the ones that often get thrown to the wind when a crisis hits. Whatever your industry, the principles of survival are basically the same: business plans, cash flow, books and records, sacred cows, lenders, honesty, and knowing when you need help. The basic principles for any owner are basic, but they are not easy to follow. Most companies plan on a six- or twelve-month horizon, and in a downturn that is too slow, so whatever shape your business is in for 2026, act with urgency. Follow these principles whether or not you are in trouble today. A business owner doesn’t have to go bankrupt to learn these lessons, but there’s never any sense in learning them the hard way.
