Signs That Your Small Business Might Be Headed for Bankruptcy

                A previous blog addressed the warning signs for consumers who may be headed down the road towards bankruptcy.  Small business owners are traditionally more reluctant to consider bankruptcy, as their business is not just a source of income, but usually represents a considerable investment in personal time, money and resources.  As a result, small business owners are most likely to ignore the warning signs that their business is struggling.  But before we discuss the warning signs, it is important to evaluate the general causes of financial distress.


–          Competition, either from the entry of new competitors into the market, or from aggressive cost-cutting from existing competitors.  It may also mean that a business is being outspent in advertising, and consequently overlooked by consumers.

–          Decline in demand for the product or services.  A recent example would be the bankruptcy filing of Kodak due to the decline in film photography (as opposed to digital) sales and processing.

–          Increase in overhead or operating expenses, such as when oil prices make airlines operate at a loss when the price of presold tickets for a particular flight does not cover the operating expenses of the flight.

–          Loss of a major client or account.  As a small business, you don’t want to have all of your eggs in “one basket”, requiring you to rely on income from one major source to operate at a profit.  An example would be a landscaping business that relies on one commercial account, and fails to generate other business in the event that the contract is cancelled, or non-renewed.

–          Catastrophe, such as the loss of an owner/partner, or loss or destruction of business property from a natural disaster, or human event, such as arson, theft or embezzlement.

SIGNS OF DISTRESS – While the causes of distress may not be immediately detectable, the symptoms of the causes may begin to manifest themselves fairly quickly, such as:

–          Decline in revenue in comparison to previous months, and also compared to the same time period in previous years (especially in seasonal businesses).

–          Loss of clients.

–          Reduction in phone calls, web traffic and foot traffic.

–          Exit of other competitors from the industry, either by attrition (such as retirement or relocation) or necessity (lack of income).

–          Increases in operating expenses, such as rent, utilities, materials or supplies.

MILD WARNING SIGNS – The symptoms of distress don’t necessarily mean that the business is in trouble.  There is always the possibility that adjustments can be made to increase revenue, either by raising prices, or reducing overhead (such as by layoffs).  But a business must be proactive.  This is why I always recommend that small business owners utilize the services of a CPA who can provide an independent assessment of the businesses finances.

–          Inability to pay invoices and vendors on time.

–          Utilizing lines of credit and overdraft protection on a frequent basis.

–          Inability to draw a salary for extended periods.

–          Infusing the business with personal savings or funds.

MODERATE WARNING SIGNS – If the business is not able to “weather the storm” in light of the mild warning signs, then matters may progress to the moderate stage.  It is at this point that the business owners need to make a realistic assessment of the profitability and viability of the business as an ongoing entity, and determine whether closing the business or making a dramatic shift in its operations will be necessary.

–          Debts have been turned over to collection agencies.

–          Customers are complaining about the inability of the business to meet obligations or deadlines.

–          Tax returns are not being filed on a timely basis.

–          Essential expenses such as insurance, bonds, licenses, rent or utilities cannot be paid, or are cancelled.

–          Lines of credit with banks, credit unions or vendors are revoked.

–          Suppliers refuse to provide materials or supplies.

–          Secured debts, such as for equipment or vehicles, cannot be paid when due and become delinquent.

–          Obtaining loans secured by personal property, such as your residence, to pay the operating expenses of the business.

MAJOR WARNING SIGNS – If you begin to witness the major warning signs, it is probably only a matter of time before the business will come to an end.  Consulting a bankruptcy attorney to eliminate your personal liability on any of the business debts would probably be recommended.

–          Unpaid sales, payroll or other “trust taxes.”

–          Unpaid income taxes and property taxes, with threats of levy.

–          Lawsuits and/or garnishments.

–          Repossession of business vehicles, equipment or fixtures.

–          Foreclosure or eviction from business premises.

–          Business deposit accounts are overdrawn and/or closed.

–          The filing of mechanic’s or materialmen’s liens.

–          Relying on payments/draws from new accounts to pay expenses/liens on former accounts.

CONCLUSION – A realistic appraisal of the business during the period of mild or moderate warning signs may not save the business, but it may prevent the escalation of debt, and potential loss of personal property.  Many times, good-hearted attempts to keep a business afloat only generate additional liabilities and bigger problems – both for the business owners, their employees, clients/customers and creditors.