Insolvency: Recognising the warning signs

Insolvency: Recognising the warning signs

There are a number of warning signs that a company is in financial distress and action is required, says Stephen Wainwright of Poppleton & Apple

Insolvency isn’t always avoidable but the chances of doing so are always improved if action is taken early and rapidly to give the company the greatest opportunity of trading its way out of difficulty. The warning signs can be singular but usually accumulate in a financially poisonous cocktail and it is important that directors and company accountants are prepared to recognise them.

Warning signs # 1: Creditor Action

Many companies and businesses occasionally miss payments; however, if this begins to occur frequently, it suggests that a business cannot meet its liabilities as and when they fall due.

This is especially the case when arrears of PAYE, NI and VAT begin to accrue. HMRC are never pleased about being used as unofficial bankers and failing to pay tax when it’s due is the number one reason why Directors may find themselves responsible for a company’s debts when it goes into insolvency. Directors are expected to know that continuing to trade with the knowledge of insolvency can have ramifications for them personally and it is important that they take professional advice from a licenced Insolvency Practitioner or to at least speak with their accountants.

Warning signs # 2: Cashflow

Most businesses suffer periodic peaks and troughs and in these circumstances, cash becomes king. Naturally, if the business is continually spending more than it earns, it will lead to financial problems. Directors very often when facing cashflow difficulties, either try to increase their overdraft facilities and/or introduce personal monies either from their own resources or family and friends. Whilst this may alleviate current cashflow difficulties, it doesn’t necessarily address the cause of the company’s cashflow issues.

Warning signs # 3: Falling Margins

We live in an extremely competitive environment and in most businesses profit margins are under more pressure than at any time in history.  Sales are critically important but it can be said that whilst turnover is vanity, net profit is sanity. No amount of turnover can compensate for a lack of profitability and if margins are being squeezed, it suggests that the costs and expenditure are too high and the sale price of goods to the end user is too low. Narrow margins make a business vulnerable to the impact of small changes in other areas of its operations from sales levels, the cost of raw materials, interest rates and even the impact of staff absences.

It is important to keep track of profitability and if this becomes an issue, it is important to liaise with the end user and your supply chain to explain the position. If neither are willing to move, then there is every reason to reconsider how the business operates and decide if it is still viable, taking advice from the company’s accountant and/or a business turnaround specialist before it is too late.

Warning signs # 4: An increase in Creditor and Debtor Days

An increase in delayed payments to creditors is a sure sign that the business is sustaining financial difficulties and very often leads to restricted credit facilities, poor credit ratings, difficulty getting supplies and increased costs due to lost discounts.

It is also extremely important that you have an effective credit controller who pursues debtors on a regular basis and is able to manage the inflow of debtor monies.  When a company is facing financial instability, cash is king.

A company should always have a business plan and maintain cashflow projections on a regular basis but, when facing financial uncertainty, those cashflows should be produced on a weekly basis and payments should be prioritised to ensure that funding levels are sustainable. If choices have to be made as to where priorities are created, that decision process should be documented and signed off by a director and should at least disclose the rationale behind the decision, the cashflow impact and identify a point at which cashflow will be regularised again and payments restored to normality.

Directors need to be realistic about the prospects for resolving issues of cashflow or profitability and however unpalatable it may seem, if losses continue to accrue or cashflow doesn’t improve, then they ought to take appropriate action and speak with a business turnaround advisor or Insolvency Practitioner.

By Stephen Wainwright of Poppleton & Appleby

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