When you are focused on the day-to-day running of a business, it can be all too easy to miss the warning signs that you may be at risk of insolvency. Often, the signs might be interpreted as a “blip” or a “minor issue” paired with the assumption that the company can trade out of it. In this article, Stephen Young identifies some of the key warning signs that directors should be aware of.

Frequently, the way a company is managed is a driving force behind financial issues. Poor communication, ignoring advice from professionals, having a high turnover of staff, having no business plan or a lack of understanding where the work and income of the business comes from are all key symptoms that can lead to financial distress.

1. Cash-flow issues

If the company’s profit margins are declining, it invariably will start taking longer to pay its creditors. The reduction in profits might be due to a slowdown in turnover, or because the company may have suffered some bad debts or made a loss on a piece of work.

Failing to pay creditors on time might result in suppliers limiting credit terms or, at worst, refusing credit. That could then have a knock-on effect on the business if it cannot obtain materials required to deliver goods/services on time.

Where cash flow is tight, it is also not uncommon for directors to use their own money to pay the debts of the business in the hope to alleviate matters.

The failure to pay creditors on time will invariably mean the company is constantly making “firefighting” calls, seeking extra time to pay or using several suppliers where previously they may have used one in order to seek any type of additional credit. The company’s own suppliers may take out credit insurance or, worse still, take recovery action against the company because they have not been paid.

2. The bank

A clear sign of financial distress is when a company is continually pushing or exceeding its overdraft or other banking facilities. Cheques may also be being returned unpaid. In those circumstances, a bank may refuse to increase its facility and may even seek to reduce it. Alternatively, a bank may require additional security, including personal guarantees from the directors or security against their personal property.

A bank may also transfer the account to a specialist team if it considers its exposure to be at risk.

Refinancing may assist in the short term but may simply be putting off the inevitable if the company is poorly managed.

3. HMRC & Companies House

A company might file its VAT returns late or not pay its tax on time when it is facing a tough financial period. In addition, a company might use money earmarked to pay HMRC to pay other liabilities in tough times.

A company may also be late in filing statutory documents at Companies House.

Failure to file documents on time with HMRC and Companies House will result in late filing penalties being levied.

Crown debt arrears will result in HMRC taking recovery action, and following an insolvency, trading to the detriment of the crown is a frequent ground used by the Secretary of State to disqualify directors.

4. Increasing debtor days

The longer debtors take to pay, the less cash flow the company has. The position is worse if the company relies on a small number of key customers which are not paying on time.

Increasing debtor days may be caused by poor company management, such as a failure to properly chase payment of invoices or, worse still, a lack of understanding as to who owes the company money.

Reducing debtor days and late payments requires proper management. A company should operate a strict debtor collection policy that is reflected within any terms of business. The company should actively chase any unpaid invoices that are close to or exceed the company’s payment terms.

A company is considered to be insolvent if the value of its liabilities exceeds its assets or it cannot pay its debts as they fall due. The fact that one or both of these factors apply to a company does not necessarily mean that it needs to close or cease trading. However, quite often seeking specialist insolvency advice at an early stage can either allow the company to properly manage the situation or allow for a strategy to be implemented that might save the business. The failure to do so is a key reason why many companies fail.