Following up on the story of Chong and Muthu, I would like to draw your attention to the cause of their problems.

Assuming I have RM100,000 to invest on these struggling entrepreneurs, and provided both of them gives the same rate of return, I will opt to assist Muthu who is facing a liquidity crisis, rather than Chong who’s facing insolvency.

In Muthu’s case, he has obviously been a victim of his dishonest cousin. However, it’s not very difficult for him to rebuild his “Telur Burung” empire since he still possess the skills and a good reputation amongst his customers. His major challenge now is a temporary crisis in cash flow and there’s a very high chance that as long as he keeps the “Telur Burung” delicious, he can easily make back the money. Also, it would help a lot that he learnt from the RM500,000 mistake.

In the case of Chong, he has been running his business using unethical methods. Hence, it is relatively much more difficult to help him rebuild his reputation and his chain of businesses. Should he recover again from this crisis, he is also much more likely to be involved in ‘questionable’ business ethics. Bailing him out is as good as throwing good money after bad ones.

Hence, it’s important that we understand what causes the underlying setback in the balance sheet, and proceed to deal with it using the right tools.

Another very common example is when a friend who is a gambling addict. You know he has been a ‘kaki judi’ all along, and one day, he took a little more risk than usual and faces bankruptcy. A very obvious case of insolvency, there’s a very high possibility that the money you are going to lend him is going to end up in the same casino where he accumulated his debts.

Say, you have a friend who has been in the business of supplying canned food. He’s the kind of person who won’t short change anyone and is very prudent with expenses. Today, he told you that one of his supplier conned him a containter of canned mushrooms, and faces bankruptcy if he cannot fulfil his obligations to his customers. Your financial assistance is probably going to help him reduce his liquidity crisis. However, it will be up to him to ensure he won’t land himself in such a situation again.

On a personal level, you can also figure out a better strategy if you can differentiate whether your existing crisis is an insolvency crisis or a liquidity crisis. When you are faced with clients who keeps dragging your payments, these clients will probably cause you liquidity problems. Of course, you cannot control how timely they pay you, but you are well-advised to ensure that you do not have too much of these clients in your business.

What about a project that does not generate profit after investing tonnes of resources in it? As much as you would like to tell yourself that the project will ‘come ashore’ one day, but fact and reality is telling you otherwise. The revenue is going nowhere but further south in the last six months. Staff morale is low and your customer service consultants are getting more complaints everyday. Yes, this project is going to cost you insolvency should you decide not to cut it off now. Like a cancerous tumour, this insolvency virus will spread throughout your organisation, eating up your manpower, profits from other revenue generating businesses and send turnover rates of your staff up the roof.

In comparison, a liquidity crisis is more like a non-malignant cyst, whereas an insolvency crisis is one cancerous cell in the system that can easily cause the demise of an organisation.

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