Seven mistakes limited company directors make

The UK might very well be on track to avoid a double-dip recession, as forecast this week by the British Chambers of Commerce, but limited company directors are still asking us what they can do to protect themselves and their business should conditions worsen, writes Gary Cousins, founder of legal advisory Cousins Business Law.

In these still uncertain times, no amount of legal or business advice can guarantee survival, let alone prosperity. That said, knowing the most common mistakes that directors make is a good starting point to help protect your business and your personal assets as much as possible. To be forewarned is to be forearmed.

Mistake 1: No management/accounting system in place

Most businesses fail due to cash-flow problems rather than anything else. It is easy for directors of limited companies to concentrate on what they do best, which is often getting the contracts or orders in and making sure they are fulfilled efficiently. As the economy remains fragile, directors will inevitably want to concentrate even more on selling or supplying, but this will be a waste of time unless a close eye is being kept on the finances too.

These days, with the many computerised and online accounting systems available, there really is no excuse for not having a good management accounting system in place. However, we still see clients who do not have adequate systems or who fail to input data correctly or frequently enough. The best thing to do here if you’re not sure is to get advice from a qualified accountant familiar with your sector/business.

Mistake 2: Jotting cash-flow forecasts on the back of a stamp

The days of easy credit are mostly behind us. If you reach your overdraft limit and then go to the bank seeking an extension, the chances are that they will say “no”. It has never been more important to stay within agreed overdraft limits and to keep on top of credit control. Not watching cash-flow closely enough, or making off-the-cuff forecasts, is not the mark of a professional supplier.

Mistake 3: The business runs you, you don’t run the business

Even if they have a long list of clients, directors we come across too often spend too much time working in their business and not enough time working on their business.

Business plans should not just be seen as a chore that has to be done before approaching lenders, advisers or other third parties. They should be seen as a vital road map of where the business is going, how, and what detours it should make to avoid problems ahead. They should be updated frequently, especially in challenging times.

So try to look ahead and predict what areas of your business are likely to grow and what areas might shrink due, say, to market fluctuations, client budget constraints or the economy.  Consider your resources, explore a contingency plan and potentially come up with a list of achievable cutbacks, particularly if you’re bigger than a sole-person business.

Generally in business, the sooner difficult decisions are made, the better. Sussing these out, at least knowing where or at what point you might need to make a tough call, is recommended in advance of that event. For example ask yourself now, if next month you can’t renegotiate terms with a primary client, what would you do? Is the risk of continuing to offer them credit, a discounted rate or generous terms on intellectual property worth it? Is it sustainable or financial viable for you, or is it going to prove too much for your business? Then try the ultimate question; how would you cope if your client or agency suddenly went bust? As you can hopefully see, it’s important to spend time regularly in ‘taking a step back’ and planning ahead.

Mistake 4: Prop up your failing company with personal cash

You need to be realistic about whether your company is going through some short-term financial problems or whether it could be failing. While injecting funds into a basically healthy company can help overcome some short-term cash-flow issues (as CCCS has made clear), it is not a good idea to use such funds to shore up a failing company.

If you do inject funds into the business, as either capital or a loan, you are likely to lose these if the company does become insolvent.

Mistake 5: Paying off Peter but not Paul

When a company gets into cash-flow problems, a mistake we often see is a director making a short-term loan to the company and then repaying it a month or two later. If you do this and the company later goes into some form of insolvency, then the court could order you to pay back those funds into the company.

The law says that, once a company is technically insolvent, it is often unlawful to pay one creditor in preference to another. Dangers can particularly arise when a director pays back a loan he/she made or pays off the bank, perhaps in trying to avoid losing money under a personal guarantee.

Mistake 6: Transfer assets or contracts to a ‘phoenix company’

Sometimes insolvency seems inevitable. Maybe you’ve got a good business but a large partner or customer of yours has just gone into liquidation owing you too much money for you to survive.

In such circumstances, it might be advisable to invoke some form of insolvency procedure and perhaps start trading through a new company. The mistake that many directors make, however, is in not taking advice early enough about how to do this while minimising their personal risk.

Transferring assets or contracts to the new company, for example, can result in having to pay back money to the old company, unless they were bought by the new company at a fair market price.

There are also various procedures to achieve the result you want so, again, the sooner you take advice the better.

Mistake 7: Just leave fellow directors to tend to their own 

We see this again and again: the sales or development director is busy getting on with their work and leaving the financial side of the business to the financial director. Maybe they don’t really understand company finances or maybe they’re just too busy to keep a close eye on them.

The problem here is that all directors are held responsible if a company fails and it is no defence to say that you left financial matters for the FD to sort out. Their mistakes could cost you dearly.

If you don’t like the way your fellow directors are running the business, you should say so and insist on it being minuted. There are advisable procedures to follow to safeguard you as much as possible so, in such a situation, legal advice at the earliest possible stage can’t be recommended enough.

Thursday 8th March 2012