Common Causes of Financial Crises: Insights from Industry Leaders

Every business, big or small, faces challenges. But when a financial crisis hits, it often feels like the end of the world. From external shocks to poor decision-making, there are several common causes behind most financial crises. 

We spoke with several experienced leaders to get their insights on how businesses can avoid financial ruin. Here's what we learned from them.

1. The Silent Killer

Erich Squire, Fractional CFO at HnO Consulting, stresses that the biggest cause of a financial crisis is cash flow mismanagement.

It's often the timing of cash flow—whether it’s slow receivables or unfavorable payables—that sneaks up on businesses. Poor management of the Order-to-Cash cycle or delayed payments from clients can create a financial storm that’s hard to recover from.

Real-Life Example:

Many businesses fail because they don’t know when their cash is coming in or going out. This lack of visibility can lead to unexpected liquidity crises. In fact, Debenhams, a UK retailer, struggled significantly due to cash flow problems, contributing to their downfall during the pandemic.

Actionable Insight:

Track your cash flow carefully, especially with freelance or project-based work. Set up clear procedures for invoicing and ensure you have a buffer to handle slow periods.

2. Forces Beyond Control

In the unpredictable world of business, external shocks such as currency devaluation, geopolitical instability, and pandemics are uncontrollable forces that can trigger a crisis. 

According to Neville Kluk, Fractional CFO at Kluk Consultancy, companies that are overexposed to volatile markets or supply chains are particularly vulnerable.

Real-Life Example:

The Brexit uncertainty and Covid-19 lockdowns severely impacted UK retailers like Debenhams, leading to their eventual collapse. The same applies to companies in sectors like hospitality and travel that were hit hard by the pandemic.

Actionable Insight:

Scenario planning is crucial. Prepare for external shocks by setting up contingency plans. Diversify your supplier base and maintain flexibility in your business model to adapt to sudden changes.

3. Believing the Hype

It’s easy for founders to get swept up in the excitement of early success, but over-optimism can lead to serious missteps. 

Mitchell Jackson, Founder of BCC Communications, warns that businesses often overinvest in things like office space or expand too quickly based on their initial success. 

Real-Life Example:

In the early days of the pandemic, certain sectors like streaming services and pet supplies had surprisingly good years, but many companies overinvested, leading to issues when demand tapered off. This happened to Groupon and Blue Apron, both of which saw explosive growth but struggled to sustain it.

Actionable Insight:

• Keep a modest approach even when things are going well. Don’t make expensive decisions based on short-term successes. Focus on building sustainable growth rather than scaling too quickly.

“You must consider the long game. When you think for the longterm, you’ll endure a day of bad headlines from a round of layoffs, so your company can regain its footing in the longterm. Consider what’s best for you and the firm’s longterm reputation, not for your image at the cocktail hour you’re attending tonight. With all crises, it’s always about the long game.” (c) Mitchell Jackson

4. Unrealistic Targets and Overexpansion

Neville Kluk also highlights that unrealistic growth targets are a major cause of financial distress. When companies set overly ambitious goals and don’t have the necessary resources to back them up, they often run into financial trouble.

"Businesses often fail to validate assumptions or test strategic models before committing capital. Decisions based on poor market research, untested propositions, or over-optimism can quickly unravel when conditions change." (c) Neville Kluk

Real-Life Example:

WeWork is a classic case of this. The company expanded rapidly, building out massive offices and hiring aggressively, only to face massive valuation cuts and restructuring. Its downfall was fueled by poor financial planning and lack of discipline in scaling.

Actionable Insight:

Set realistic targets that align with available resources. Break down goals into manageable steps, and ensure you have the financial foundation to support them.

"Many businesses pursue aggressive growth or high-risk ventures without sufficient capital buffers, contingency planning, or stress testing. This often results in liquidity crunches when early setbacks occur." (c) Neville Kluk

5. Lack of Checks and Balances

Governance is critical to a company’s survival, and when internal controls break down, businesses are often left exposed to catastrophic failures. 

Kirr Simakovs, Founder of Monosnap, points out that some businesses fail when leadership doesn’t maintain discipline and start making decisions based on overconfidence.

Real-Life Example:

The Enron scandal is a prime example of this. Enron’s leadership made poor decisions, ignoring red flags, and was eventually caught up in fraudulent activities due to weak internal governance.

Actionable Insight:

Establish clear governance structures within your business. Make sure you have checks and balances in place, and never let one person have too much power over critical financial decisions.

6. Failing to Adapt

Another significant cause of financial crises is technological disruption. Businesses that fail to innovate or adapt to changing technologies risk being left behind. Kodak is a classic example of this. 

Although Kodak invented the digital camera, it was too afraid to embrace the shift, fearing it would cannibalize its film business. The company’s eventual bankruptcy was a result of its failure to adapt to the digital age.

Actionable Insight:

Don’t resist change—embrace it. Regularly assess the technological landscape and ensure your business is adaptable to new trends, whether it’s AI, cloud computing, or digital marketing strategies.

We saw this during the pandemic: Certain companies had shockingly good years (think: streamers and dog stores), over invested, and then now they’re in trouble. During the meaty times, prepare for the lean times.(c) Mitchell Jackson

Conclusion: How to Avoid Panic in Tough Times

The key to managing financial crises is to stay calm and act strategically. As Mitchell Jackson wisely advises, “Stop listening to your emotions.” Make decisions based on facts, and focus on the long-term game.

• Be objective in your decision-making.
• Keep a clear view of your cash flow.
• Have contingency plans in place for both success and failure.
• Act fast when necessary, but always with a clear plan.

By following these lessons, businesses can prepare themselves for the unexpected and emerge from a financial crisis stronger than before.