Potential Business Failure Calculator

Potential Business Failure Calculator

Business failure is real and can be painful for owners, employees, investors, customers, suppliers, creditors and other stakeholders in the community. Government is a big customer for government contractors. The government does not want to take on a vendor that has the potential to go bankrupt within a year or so. In order to protect itself from a sudden potential bankruptcy by a contractor, increasingly the small and mid-sized government contractors are receiving requests from government agencies to conduct a financial capability analysis.

A financial capability analysis is an evaluation of a company’s existing and future financial capabilities to continue operations in the near-term. It also analyzes the company’s financial condition and cash flow forecasts as an indicator of the company’s ability to perform in the future. Normally, a small or medium sized firm will hire a CPA or Management Accountant to assist them as they go through the government’s capability review. In some cases the company will get a pass for presenting a ‘good story.’

There are multiple financial and non-financial ratios that enable an owner to assess the financial position, cash flow and results of operations. But many of these ratios do not tell you whether you are in danger of going bankrupt in the near future. There two models to measure your company’s potential for business failure, which we present free of charge for you or your CPA to calculate:

Z-Score and Argenti H-SCORE

Note 1
The pass mark for Altman’s Z score was three, above which companies would be considered relatively safe. Companies with Z scores below 1.8 would be classified as potential failures; scores between 1.8 and three were in a grey area.

Note 2
Each weakness/deficiency is given a mark (as shown) or given zero if the problem is not present. The total mark for defects is 45, and Argenti suggests that a mark of 10 or less is satisfactory.

Note 3
The suggested pass mark for mistakes is a maximum of 15.

Note 4
Usually, companies not at risk have fairly low scores (0–18 being common), whereas those at risk usually score well above 25 (often 35–70).

Note 5
The overall pass mark is 25.
Usually, companies not at risk have fairly low scores (0–18 being common), whereas those at risk usually score well above 25 (often 35–70).

General Comments

While Argenti’s model is perhaps the most notable, a large number of non-accounting or qualitative variables have been included in other studies. These include:

1. Company-specific variables – such as management experience, customer concentration, dependence on one or a few suppliers, level of diversification, qualified audit opinions, etc.
2. General characteristics – such as industry type.
3. Factors in the external environment – such as the macroeconomic situation, including interest rates, the business cycle, and the availability of credit.

Other Symptons of Failure

1. Failure to focus on a specific market because of poor research.
2. Failure to control cash by carrying too much inventory, paying suppliers too promptly, and allowing customers too long to pay.
3. Failure to control costs ruthlessly.
4. Failure to adapt your product to meet customer needs.
5. Failure to carry out decent market research.
6. Failure to build a team that is compatible and has the skills to finance, produce, sell, and market.
7. Failure to pay taxes
8. Failure of businesses’ need to grow. Merely attempting stability or having even less ambitious objectives, businesses which did not try to grow didn’t survive.
9. Failure to gain new markets.
10. Under-capitalisation.
11. Cash flow problems.
12. Tougher market conditions.
13. Diversifying into new, unknown areas without a clue about costs
14. Managers/owners spending too much money on frivolous purposes thus using up all available capital.

Ultimate reasons for business failures are

1. Poor business planning
2. Poor financial planning
3. Poor marketing
4. Poor management