As a business owner, you might live with the constant fear of going bankrupt. It helps to understand the top reasons for small business bankruptcy in Canada so you can help prevent your business from failing. Let’s look at the most common reasons businesses file for bankruptcy and some tips to help avoid them.
What Is Business Bankruptcy In Canada?
Business bankruptcy occurs when a business is unable to pay off its debt. This means they are “insolvent” and unable to pay bills now or over the long term. Insolvency is usually due to issues with poor management, ineffective marketing, or insufficient finances. However, external causes can also contribute to bankruptcy, such as what occurred during the pandemic or downturns in the economy. Bankruptcy is also a legal process that facilitates the repayment of creditors, allowing companies to find their way to a fresh start.
What Actions Do Businesses Take When Faced With Bankruptcy?
There are three options when a business is facing bankruptcy in Canada:
1. Voluntary assignment: This is the voluntary assignment of assets for the general benefit of all creditors.
2. Involuntary assignment: In this case, creditors file a petition in a provincial court for a receiving order against the debtor’s assets.
3. Deemed bankruptcy: This applies when a debtor has started the insolvency process but fails to meet the requirements for filing a Division I proposal in bankruptcy under the Bankruptcy and Insolvency Act, or to adhere to the provisions provided within the proposal after it has been filed and accepted by the creditors/court.
Is There An Alternative To Bankruptcy For Businesses?
A Division 1 proposal can be made to creditors to negotiate debt repayment. Most creditors prefer this over bankruptcy as it helps secure more of the debt owed. The proposal is a procedure governed by the Bankruptcy and Insolvency Act, which is carried out by a Licensed Insolvency Trustee (LIT). Also known as a commercial or corporate proposal, Division 1 can be used when:
- The business is insolvent but still potentially viable
- The business owes more than $250,000 in unsecured debt or less than $250,000, but its structure is complex
- The business is a corporation and not a sole proprietorship or partnership
There is also the option for corporate reorganization that restructures outstanding debt and operations to improve financial health, as well as debt consolidation to help avoid bankruptcy.
Most Common Reasons Businesses File For Bankruptcy
Here are the most common reasons businesses file for bankruptcy, with tips to avoid them:
Unforeseen external factors
This would include scenarios such as economic downturns, natural disasters, or COVID. These events can have a devastating impact on your business if you lack strategic planning to help you quickly pivot to keep finances sustainable.
Tip: It’s always advisable to maintain an emergency fund that allows you to remain operational and honour your financial obligations until you overcome downturns. The goal is to avoid further debt accumulation that increases the risk of insolvency.
Health issues
Small business owners are vulnerable to the negative impact health issues can present, whether it’s due to an injury or illness. When you can’t work, your business can come to a standstill if you’re the main person running the show. You can also face issues if a key member of your team falls ill.
Tip: Have a contingency plan that allows you to maintain business as usual despite illness. This includes understanding your limits related to your condition and determining if there are parts of your business you can continue to run. Keep records that make it easier for someone else to step into your place temporarily to limit business disruption that leads to lost profits. Also, set aside funds to help you weather the storm for as long as possible without relying on credit.
Poor cash flow management or insufficient cash flow
Your cash flow might seem healthy, yet when it comes time for payroll or fulfilling your financial obligations, you always fall short. This indicates poor cash flow management. It can also be insufficient cash flow, which means your profit margins are off or your sales are down, so you can’t keep up with your cash obligations.
Tip: Keep an eye on the books to ensure you understand your financial health. Speak to an accountant or fractional CFO to introduce cash flow management strategies such as efficiencies in accounts payable/receivable management and effective tax planning. You should also pay new suppliers on time so you can earn favourable payment terms that reduce the risk of getting into debt.
Skills gaps
If you’re more of an ideas person than a financial or business whiz, those skills gaps put your solvency at risk. If you lack the skills to prioritize your spending and know how to maintain a budget, you or key team members can contribute to business failure. However, skills gaps such as marketing can also reduce your ability to grow your customer base, which also leads to business failure.
Tip: Find qualified people to step into roles you aren’t qualified to fill. For example, an accountant or someone like a fractional CFO can oversee your finances and ensure you’re doing everything you need to remain profitable. They can introduce strategies, such as knowing how to access funds without risking increasing debt, and can track cash flow to find opportunities for capital investment.
Excessive borrowing
Businesses that rely solely on loans to fund their businesses ultimately fail. Borrowing can provide the cash needed to start and grow your business. However, borrowing leads to debt that can become overwhelming without proper management. You need to finance your business but also understand how to repay creditors so you remain solvent.
Tip: Never borrow more than you can repay. Each loan should include a manageable repayment plan based on your books. You should also ask for financial advice so you understand how to leverage various sources, whether it’s investments, grants, loans, or something less conventional like crowdfunding.
What Happens To A Business When It Goes Bankrupt?
When a business goes bankrupt, it must file a petition with a bankruptcy court. If the court grants the petition, a Licensed Insolvency Trustee (LIT) will take over all assets and sell them off to pay back creditors. Business operations will stop, and the business closes down.
The truth is, making a profit doesn’t guarantee you can avoid bankruptcy. Whenever you have cash shortfalls, you are at risk of falling into debt and becoming insolvent. As a result, you need to have a financial management strategy in place that avoids unnecessary debt, which helps avoid business failure or bankruptcy.
Speaking to a team of professionals to help manage your financial strategy is the best way to keep your business on track for success. Call Intrepidium today at 778-800-7976 or click here to schedule a consultation.
