Early signs of insolvency

Management of business debt can be difficult whether your business owes money to a supplier or alternatively if a client owes your business money. Businesses go through cycles of ups and downs and it is important that you can identify when your business maybe heading towards financial distress in order to avoid insolvency. So, what are some of the signs of financial distress to look for:-

– Inability to make payments to your suppliers or service providers within the agreed payment terms;

– You find it necessary to enter into payment arrangements and/or are placed on cash on delivery (COD) agreements by your creditors;

– Being unable to pay your ATO liabilities by the due date; and

– You have begun receiving documents such as demand letters and statements of claim from suppliers.

While it may be clear to an Insolvency specialist, Directors and Managers of companies will often ignore these vital warning signs, either wilfully or otherwise. Such an approach whilst maintaining the façade of solvency in the short-term, can and may lead to business failure in the future.

For businesses in a stronger financial position, constant monitoring for the early indicators of financial difficulties can allow them to avoid or mitigate the risks of insolvency. In this regard, the use of specific financial indicators can assist in revealing weak points in the business which if left unattended could lead to future financial problems.

Key indicators such as the gross profit margin or ‘debtor days’ can be used to gauge the future solvency of a business. The gross profit margin is beneficial in that it indicates the profitability and thus the continued viability of a business. If the gross margin is decreasing, or persistently below the industry average, this may indicate deeper structural problems within the business that could ultimately lead to insolvency.

The concept of ‘debtor days’ is also useful in assessing the strength or otherwise of a business. ‘Debtor days’ refers to the average time taken by customers to pay their debts to the business, and ultimately affects the cash flow of a business. A high figure (above the industry average) could indicate problems with debt collection procedures of a business or the financial position of major customers.

Whilst profitability issues can eventually lead to insolvency, there also exists the much shorter-term threat of a cash flow crunch. Such a problem can quickly arise when there is a mismatch between the credit terms offered by suppliers and the terms offered to customers of the business. Other causes of cash flow problems include the excessive use of credit to fund capital expenditure or poor stock management.

Ultimately, vigilance is the key to the satisfactory performance of any business. Should you feel that your business is heading towards financial distress, the assistance of a qualified business advisory firm may be the key to your businesses financial future.