In spite of your best efforts as a business owner, sometimes you must think about closing a company division or product line. Exiting a particular business is one of the most difficult decisions youβll make as an owner. You may deal with feelings of failure and rejection, given how much effort youβve put into the operation. So, how do you make an informed decision? Use these tips to understand the financial and non-financial issues related to closing a business.
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Running a business
How to know when to close your business
Meet John
John owns Quality Sporting Goods, a company that manufactures cricket, basketball, and hockey equipment. The companyβs Centrefield Gloves division produces cricket gloves, and the division has lost money for the last three years. Management has tried various strategies to improve Centrefieldβs results. John invested more dollars in sales and marketing and attempted to negotiate lower material costs with vendors. Centrefieldβs glove competitors sell a high-quality glove at a low price, and Johnβs firm cannot gain any market share.
John is now considering shutting down the Centrefield division.
Where are you now?
The first step to making an informed decision is to understand your current financial results. Here is the Centrefield income statement and balance sheet for the end of December:
The income statement indicates that Centrefield generated a $30,500 loss for the year, and this report separates costs into the cost of sales and operating expenses.
Cost of sales includes material costs (leather and plastic), and labour costs that are directly related to production. If the division is closed, these costs are eliminated.
Operating expenses include costs that are not directly related to production, and this category requires more analysis.
Dealing with sunk costs
Sunk costs are expenses that will continue, even if your close a division or product line, and these costs need to be carefully reviewed.
Centrefield, for example, has five years remaining on the home office lease, which will cost $50,000 over the remaining lease term. All other costs can be eliminated.
If the division is closed, all of the incoming revenue will stop, along with all division costs β except for the $50,000 in lease payments.
Liquidating the Balance Sheet
If John decides to close the division, he can generate cash from selling assets, and use that cash to pay off any outstanding liabilities. If assets are greater than liabilities, this βliquidationβ process will leave John with an ending cash balance. Hereβs the balance sheet impact if the Centrefield division is closed:
- Cash inflows:Β In addition to the $40,000 cash balance, John collects the $70,000 in receivables from customers, and sells the $30,000 glove inventory to the existing client base. The business also sells the machinery and equipment, and Centrefield receives a total of $185,000 from asset sales and the original cash balance.
- Cash outflows:Β John pays $30,000 to eliminate the accounts payable balance, and repays both the $20,000 current portion and $100,000 long-term portion of the bank balance.
- Remaining cash:Β The net impact of liquidating the balance sheet is a $35,000 increase in cash, which equals ownerβs equity. The equity balance is the current amount of cash and other assets that John invested in the business.
The bottom line is that John will recover his $35,000 equity investment in the business, and John will have to pay $50,000 to finish the lease term. However, Quality Sporting Goods may be able to use the office for some other purpose until the lease ends.
Non-financial costs
Closing a division involves non-financial costs that will impact your business, and John should carefully think about the impact of closing his company division.
If the division is closed, it will impact on employee morale. The staff may wonder if other departments will be closed and if more jobs will be eliminated. Low morale can impact productivity, and some workers may consider leaving the business.
Investors, creditors, and vendors may question managementβs ability to operate the business moving forward. Investors may consider selling their ownership interest, and creditors may ask for more collateral to secure a business loan. Vendors may be hesitant to sell goods and services to Quality Sporting Goods unless cash is paid up front.
When a company division is closed, many people will question the ownerβs ability to manage the business.
Can I close a company with debts?
In short, you need to pay off outstanding debts to close your business. However, paying debts can be difficult if youβre closing your business because itβs not doing well financially. For example, you might decide to close your business because:
- Youβre not making enough revenue to cover overheads and operating costs
- You canβt cover operating costs while trying to sell your business
Being unable to pay your business debts is called insolvency.
If you think you might be insolvent, donβt panic. There are several options to explore:
- Consider whether you can sell some or all of your business assets to pay off your debt
- Contact the ATO for support with setting up a payment plan if your debt is tax-related
- Contact your lender to discuss your circumstances and see if your repayment schedule can be adjusted
- Talk to an insolvency practitioner or lawyer for advice on how to proceed
Finding a way to pay off your debts can help you close the business without any long-term impacts, such as bankruptcy.
Can I reopen a closed company?
Yes, if your business was set up as a company, you can apply to reopen it via the Australian Securities & Investments Commission (ASIC).
To apply to reopen a closed company through ASIC, you:
- Must have been a director, secretary or member of the company at the time it was closed (βderegisteredβ),
- Must be able to confirm that the reopened company will be able to pay its debts as and when they fall due
- Canβt be disqualified from managing corporations
- May need to provide supporting documentation as to why the company should not have been closed
Find out more on the ASIC website.
If you were registered as a sole trader, youβll need to re-apply for an ABN. You can do this through the Australian Business Register. If you think your business will have a GST turnover (gross income from all businesses minus GST) of $75,000 or more, youβll need to register for GST.
When reopening a business, itβs a good idea to check whether you need to:
- Register your business name and any trademarks
- Repurchase insurance, licences or permits
- Set up small business accounting software
- File any other documentation or paperwork
Depending on your situation, it could also be worth putting together a business plan outlining your updated value proposition and objectives. A solid business plan will help set you up for success during the next phase of your business venture.
Take everything into account
Closing a division is a tough decision, and you must evaluate both the financial and non-financial impact of your change. However, in many cases, closing a business unit is the right thing to do, and will allow you to focus on more profitable areas of your company. Think carefully about this decision, and take everything into account, so you can grow your business profitability.
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