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Avoiding the Crash Course in Business – Lessons from the Financial Crisis for Business

By Jon Sawyer on 15/02/2017 - 0 Comments

The financial crisis from 2008 onwards, had a number of causes and certainly gained significant momentum with the collapse of Lehman Bros – a global world bank. It has taken huge taxpayer funded bail outs to establish a level of stability in financial markets.

The causes are fairly complex and are attributed both city bankers and regulators alike. The reality is that this has been a costly lesson with the public at large paying the price for poor financial management by all concerned.

How can business owners now learn from these mistakes to ensure they can navigate a more successful course in managing the finances of their businesses?

The first cause of the crash can be identified as the bankers themselves. They had developed investment options that lost track of accurately measuring financial risk. The backdrop of low inflation and stable growth led to a complacent attitude toward risk taking.

Many factors combined led to a massive increase in debt which in the form of mortgages, and were repackaged into collateralised debt obligations (CDO’s), which were all validated by Triple-A ratings by agencies such as Moody’s and Standard & Poor’s. When the bubble burst the full level of exposure became apparent. Low levels of interest left bankers with seemingly no other alternative other than to seek out more risky investment options.

The banks themselves also contributed to the crisis as their level of level of liquid assets was not sufficient to cover such losses. In short, pressure from shareholders to increase returns encouraged banks to operate with minimum equity, and so they became very vulnerable if things went wrong – they had too little capital to absorb such losses.
This led to a credit squeeze where banks became reluctant to commit to short term loans.

The loss of short term credit led to the demise of Northern Rock in 2007.

City regulators also should bear the burden of responsibility for mishandling the crisis. The panic that beset markets following the bankruptcy of Lehman Brothers could have been avoided. In not rescuing Lehman’s, regulators had to rescue many other potential casualties.

Regulators should not have tolerated the situation that led to the housing bubble. As a result, countries such as Italy, Spain and Ireland became vulnerable from the impact of housing bubbles in their local markets.

Central banks could have done more. They could have placed restrictions on the credit surge, and ensured that the housing bubble was controlled by lowering loan to value ratios for mortgages. The benefit of hindsight affords 20/20 vision, but there are many lessons to take from the crash of 2008.

The first is that if something sounds too good to be true, it often is. Chasing down the highest return at the expense of a strategy that may deliver a more sustainable and long term profitable platform should be given priority. Moreover, properly having sufficient controls in financial management will positively impact cash flow. Only by having sound financial tracking and reporting processes with clear measurement criteria can performance be evaluated.

Often these are lost at the expense of the requirements of day to day management of the business. On reflection, it is clear that the financial climate that led to the crisis did not come about overnight - it took place over many years, but only took a few moments to unravel.   

The main lessons are to be viewed in terms of having prudent financial planning and management processes at the heart of any business. Without this things can go wrong for any business as internal models to assess performance may not be robust enough leading to increased vulnerability.

Evidence of this is the number of SME bankruptcies which is consistently around 80% for newly established businesses within a 24 month period, with cash flow being the main reason for failure. History in this case should certainly direct future action for the prudent business owner.

If this rings any alarm bells - speak to your local ICON advisor.

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