How to avoid business failure
Let me summarize the situation. A young couple started a business venture, in which they supplied and distributed electronic security systems for institutions and businesses. They have grown their customer base quite well in five years. They also received larger orders from semi-governmental organizations. Then they got stuck with payments to suppliers, that’s when they contacted me. In the previous column, I had written about the choices for a small business in need of working capital (How to Run a Small Business).
Now it turns out they have loans from several friends and relatives, as well as a large outstanding loan from a local NBFC. They don’t have enough money to cover these loans. Parents are now involved, as well as a group of close relatives and friends. They want to know what the way forward is. It’s unfortunate, but responses to my previous column tell me that this problem is more common than I had imagined.
An independent accounting of all assets and liabilities must be carried out. Without knowing what is owned and owed, we cannot proceed to the next steps. Jewelry has long been pawned; investments in a few deposits and mutual funds have been liquidated; we are now talking about mortgaging the house. It’s a red flag. If the house they live in is being considered for a mortgage, it could actually mean that there are no other assets to liquidate. They are also known to have taken manual loans from many people. Small amounts that add up to a lot even without interest. The NBFC loan is not against payment of bills, but a personal loan at a high interest rate. The denouement of the crisis occurred as collectors appeared at the door. A friendly CA or trusted friend or relative should make a complete list of all loans, using bank statements, phone and message records, and conversations with the couple.
In a small business run as a sole proprietorship, there is no separation of personal assets from business assets. If the assets are known to be worth more than the liabilities, they must liquidate and pay. There is no possibility of seeking bankruptcy protection unless the liabilities are higher. Without numbers, there’s no way to write a plan to clean up this mess and start over.
How to Run a Small Business
How to Run a Small Business
There is no point in applying for other loans to repay what has been borrowed. Without any income to repay a loan, taking out a loan only line the pockets of lenders as assets will be liquidated to meet outstanding balances. The family has no income other than a small government pension that could cover basic household expenses.
Seeking interest-free loans from friends and well-wishers will create an unnecessarily easy way out for offenders who have taken out loans. It turns out that the young couple did not differentiate between income and profit. When large sums began to flow in, they began to spend them on a luxurious lifestyle. They seemed somehow confident that as the sales rolled in, they would make up for the money they got out of the business.
After getting used to the ostentatious lifestyle, they began to borrow. Outsiders thought the company was doing very well. The immediate family remained very impressed with the couple’s “progress”. They did not do any strategic analysis of their working capital needs or their financing needs. Instead, they continued to dip into the income generated by the business and felt satisfied with the influx from time to time. They took out loans when they couldn’t match the cash flow. What has been recklessly spent will have to be painfully repaid. Bailing them out will only perpetuate their reckless behavior.
If they only have one house, they should sell it, even if it’s a distress sale, pay off all their loans, downgrade to a smaller house, and start over. They can also choose to invest the proceeds of the sale wisely in well-managed financial instruments to generate income for the household, and to keep their rent until they find another job and a stable income.
Not having accounts and records is a bad way to start a business. The CA who files their tax returns admitted that they hardly provided him with adequate information to do his job honestly. Since the filing was for individual returns and the company’s annual earnings did not exceed the minimum limit of audited accounts and returns, the show continued. The TPS account was poorly maintained. Bank accounts have all been merged between personal and business transactions.
Many believe that business transactions of this type are a “smart” way to evade taxes. It is not only criminal, but also reckless. When a company has proper accounts, control is better. Owners who think revenue is bottom line are terrible money managers. When they needed a loan, they could have gotten it at lower rates from their bank as an overdraft, or from an NBFC by discounting their bills, or taking loans on assets instead. to liquidate them. Prices would have been lower.
They could have charged many business expenses against their business income and planned their taxes effectively. With poor records, they suffered more than they could have gained by avoiding taxes. The money they drew has been spent. If it had been used to acquire assets, they would have had a fallback. Farmers with uncertain incomes bought cattle and gold when crops were sold. These assets were traded during lean months to provide comfort for the family. Many new business people don’t see the point of having quickly marketable assets. Buying jewelry is not a good idea if it never sells or is pawned and lost in distress.
Their business failure shows how some first-generation entrepreneurs don’t give financial strategy, financing, capital estimation, accounting and taxation the importance they deserve. Being reckless is also twisted and costly, and there’s nothing innocent and naive about it, as parents would have me believe.
(The author is PRESIDENT OF THE CENTER FOR INVESTMENT EDUCATION AND LEARNING.)