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Stand Guard
Bankruptcy can sneak up on you if you aren't paying attention.
To keep your business safe, be on the lookout for these warning signs.

By C.J. Prince | Entrepreneur Magazine - June 2007

Just because it is costlier and more difficult to file for bankruptcy now than in years past does not mean that fewer businesses will wind up doing it, particularly if former Federal Reserve chairman Alan Greenspan's warning of a recession later this year materializes. A January poll by the American Bankruptcy Institute found that 71 percent of respondents anticipate bankruptcies among small and midmarket businesses to rise substantially in 2007. "It's the law of gravity," explains John Penn, bankruptcy attorney with Haynes and Boone, one of the nation's fastest-growing law firms. "What goes up will come down."

At least that's true for some over-leveraged businesses that have simply kept borrowing to plug the holes and keep from sinking, says Jennifer Emens-Butler, partner at Obuchowski & Emens-Butler, a firm that specializes in business and consumer bankruptcy. "If they have not fixed what is broken, when interest rates rise even slightly or hedge funds start calling in their loans for whatever reason, that could [result in] a pretty serious crash."

The trick to avoiding bankruptcy is to ditch denial and recognize the warning signs six months to a year before a minor cash flow problem mushrooms into a dire situation. Here are a few things to watch out for.

Always paying late: One of the more insidious signs of trouble is when payables start piling up, says Jerry Silberman, founder and CEO of Corporate Turnaround. It's common for entrepreneurs to have a number of items in the 30-day column, he says. "But once you hit the point where 30 percent of your payables are 90 days old, that's a serious problem."

The problem can snowball quickly if suppliers giving you unsecured credit find out you're having trouble; they may squeeze you by shortening their credit terms, says Bill Lenhart, national director of business restructuring services at BDO Seidman LLP. Take a hard look at your payables and your cash situation, and figure out what it would take to pay off your debt. If you need a short-term payment plan to get through a down cycle, call your suppliers, vendors and creditors and work it out with them. Don't wait until their patience has run out.

Borrowing to pay debt: Borrowing money to fund a well-thought-out expansion or to boost inventory to meet demand can be a smart strategic move. But running up more and more debt, particularly on high-interest credit cards, just to pay the monthly bills or hide other debt is a big mistake. And so is tapping your 401(k) funds to prop up the business, says Cathy Moran, attorney and founder of Moran Law Group. Look for other ways to create liquidity—selling off excess inventory, for example—or sharply cut expenses. That may mean asking employees to take a temporary pay cut or forgo bonuses. "One of the most important things is communication because you need to rally your troops around this," says Lenhart.

Falling behind: If you aren't managing to balance the checkbook, file your tax return or keep financial records up-to-date for an extended period of time, that says you're not minding your business properly. It's this kind of fog that can lead you to believe, for example, that sales are profitable when you aren't actually generating cash because there is too much inventory sitting on the balance sheet, says Lenhart. If you were able to catch that in time, you could slowly reduce inventory, generate cash and get out of trouble.

The best defense is a good offense. No matter how busy you are running day-to-day operations, make time to do the strategic planning that keeps your business moving forward, says Emens-Butler. "It sounds sort of old-school, but you've got to have those board meetings and sit around and really talk about the future," she says. Take a proactive approach now so that when the next storm comes, you'll be one of those still standing afterward.

C.J. Prince is a New York City writer specializing in business and finance.