What are the legal consequences of poor financial management?

Just under one-third of businesses fail due to a lack of cash, which is why it’s vital for you to manage your finances well. Losing money has far more impact than just missed business opportunities: it also has legal consequences. 

Learn more about the legal consequences and business implications of poor financial management in this article. We’ll walk you through the implications for each main business structure in the UK and how to protect yourself, including:

• Legal consequences for sole traders
• Legal consequences for limited companies
• Business consequences on your future trading
• How to improve your financial management

As a sole trader, you and your business are considered one and the same from a legal standpoint. As you borrow money to grow your business, the credit and loan liability is placed on you personally.

Because of this, poor financial management can affect your personal financial circumstances heavily and in a variety of ways. First and foremost, lenders may take you to court if you’re unable to pay back loans or credit agreements. This may result in having to sell your personal assets to settle the loan amount, including things like your car or van, electronic equipment or appliances, and property. 

Secondly, poor financial management can also impact your ability to take on new loans in the future. This may occur as entirely losing your lending options (depending on how serious your mismanagement was), or charging you higher interest rates to cover your increased lending risk. Similar to before, poor financial management as a sole trader can impact your personal and business finances going forward. For example, you may find your business history impacts your ability to take on a mortgage.

Finally, you may run into legal difficulties with HMRC if you don’t keep accurate records of your business’ trading. At a minimum, HMRC may apply penalties or interest to unpaid or late tax amounts, with more serious considerations of tax evasion and prosecution depending on how poor your financial management is.

If you’re a limited company director, you enjoy a more distinct and separated relationship from your business. However, this doesn’t mean you won’t face legal consequences for your personal and business’ finances from poor financial management.

If company directors don’t meet their responsibilities, they may face a number of consequences. In particular, if they don’t manage the company’s finances properly, they may be removed from their position as director by shareholders or be barred from running a company for up to 15 years. This is called ‘disqualification’ and can affect your personal finances and ability to make money during this period.

Similar to before, your company may run into legal difficulties with HMRC if you don’t keep accurate records of your business’ trading, with the same legal consequences of penalties or compliance investigations being applied (depending on the severity of your mismanagement).

Company directors are scrutinised internally and externally: by shareholders and the various government authorities that oversee companies within the UK (namely Companies House and HMRC). In doing so, they take several viewpoints into account when deciding whether company finances have been managed well. These may include:

• The priorities of shareholders and their dividend payments
• The growth and investment strategy of the company as a whole
• The steps taken to manage the company and its assets according to the articles of association
• The reputation the company has as a business and whether this is increasing in value

Note that, even if you’re the only shareholder within your company currently, you’ll still be held to account by Companies House and other UK regulatory bodies. Similarly, if you overstep your bounds as company director and take a financial decision that wasn’t yours to make (as specified in the company’s constitution and articles of association), you may be made personally liable for any repayment to the company.

For more information on company directors’ duties and responsibilities, read our article: What does a director do in a company?

The business consequences of poor financial management are tied to the legal consequences: problems with your financial performance often start small and result from poorly researched market trends or inexperience with accounting standards. 

In turn, these decisions impact your ability to grow your business and capitalise on investment opportunities. This can create a cycle that’s difficult to break if you don’t know how to approach financial management. On the whole, we recommend learning about and keeping in mind key metrics for your business success, such as:

• Gross and net profit
• Cash flow
• Assets and liabilities
• Changes in your target market
• Cost of goods
• Business plan and budget

Learn more about financial management and how these aspects of your business fit together in our article What is financial management? If you’re facing more intense difficulties while running your business, read our article How to save a struggling business for more target advice.

You can avoid the legal consequences of poor financial management using a simple app like Countingup. 

It is the two-in-one business current account with free, built-in accounting software. Built to help small business owners save time on bookkeeping admin, the app comes with key financial management tools to make your life easier, like tax estimates from your trading performance and automated invoicing.

It allows you to understand your business’ growth at a glance with its real-time profit and loss insights. Gain complete confidence in your new business’ financial records. Find out more about here and sign up for free today.