Five Phases of Business Failure
Five Phases of
Business Failure
Of the thousands of businesses that commence trading each year, only a few will prosper and survive in the long
term. This changes very little from year to year. Based on experience, Phillipsons has identified what we call the
Five Phases to Failure (5PF) and the elements that are likely to be found at each phase. Let us take a look at these
phases.
1. Confident Phase (The Rise)
New business owners are full of confidence, high expectations and enthusiasm during early trading. However,
with little or no business experience or knowledge of budgeting, accounting or financial management, they are
unmindful of obvious pitfalls.
During this phase we can expect to see:
(i) Good trading with a reasonable demand for the product or services offered.
(ii) Increasing turnover. New business is won at the expense of more established competitors.
(iii) Suppliers offering discounts and credit to win supply contracts.
(iv) The business products and the staff are innovative and ahead of competitors.
(v) Directors are happy to sign personal obligations and guarantees.
(vi) Financial statements and budgets are prepared, although not necessarily deeply analysed.
(vii) New premises and/or plants are brought online.
(viii) Expansion is often funded on finance, because of limited capital.
(ix) Turnover growth is considered critical, but the cost of these sales is not fully understood.
(x) Regular drawings are made by owners.
(xi) Great plans for future expansion are confidently discussed.
(xii) Staff bonuses and incentives offered.
2. Consolidation Phase (The Plateau)
At the end of the ‘honeymoon’ period, business owners should seek advice from their accountants, who can
help them to consolidate. With sound advice, some will build on their foundations of budgets and capital. They
need to be disciplined, knowledgeable and pragmatic, and to instil confidence in their financiers, customers and
suppliers about the strengths of the business products, service and finances.
Those that don’t adapt to the new conditions can expect to see:
(i) Sales getting harder to win and increased competition.
(ii) Turnover becoming stagnant or reducing for two or more consecutive periods.
(iii) Current asset ratio weakening.
(iv) Closer attention from the bank and investors.
(v) Margins being squeezed as suppliers end their early discounts and prices have to be dropped.
(vi) Credit being harder to obtain from suppliers who require guarantees from directors.
(vii) An intermittent inability to meet all commitments - the overdraft balance increases.
(viii) Grand plans quietly downgraded to more realistic levels.
(ix) Uncertainty about the business’s ability to trade profitably in the future.
(x) Preparation of financial statements becoming less regular and less rigorous.
(xi) Directors and owners becoming less enthusiastic.
(xii) Long periods being spent on managing cash flow rather than managing profit.
3. Debt Phase (The Decline)
Tough trading conditions have led to real financial problems. A steady decline will continue until the business
closes or sufficient bottom line profits are earned to cover past losses.
A business in the this phase is usually characterised by:
(i) Creative accounting being used for reporting to banks and investors.
(ii) Spending is reduced on non-core activities, including marketing.
(iii) Further and greater use of ATO funds and failure to remit superannuation monies.
(iv) Further slippage in turnover, margins and profits.
(v) Quality customers are lost as they find more stable suppliers.
(vi) A need for longer term ‘arrangements’ with some creditors.
(vii) Some suppliers only supplying on COD basis.
(viii) Planning is done on a day-by-day survival basis.
(ix) Accountants consulted, but advice generally ignored.
(x) Internal systems and controls begin to break down.
(xi) Management’s main preoccupation is demands from creditors.
(xii) Insolvent trading is now an issue for company directors.
continued on next page
Related links:

McKinsey Problem Solving Test
Boost Africa Initiative - FAQ
How a problem becomes a good business idea
Gender Differences in the Causes of Business Failure (Study)
Africa-EU Renewable Energy Cooperation Programme (RECP)
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