At this difficult time, no business wants to think about its suppliers or customers going under, and an invitation to take part in a creditors’ decision-making process for an insolvency procedure can come as an unwelcome surprise. However, this is not the only way to spot a company in financial difficulty and there are some early warning signs that we have seen distressed companies exhibit. Reading the signs early and acting appropriately could reduce the number of creditor invitations you receive, and help prevent your own financial difficulties.
Legal action by creditors
Given that legal action can increase the amount needed to be paid (because the creditor may be able to recover their legal costs from the debtor and be entitled to claim interest at 8%), most businesses try and avoid matters getting to this stage. If a company has a number of un-satisfied judgments against it and the frequency and amounts of the judgments are increasing, this suggests the company is struggling to pay in full and on time.
Late or non-filing of company accounts
Late filing might be due to a valid reason unrelated to the company’s finances, (and the Corporate Insolvency and Governance Act 2020 has extended the periods in which a company must file its annual accounts). Putting that to one side, a common reason can be the firm’s lack of money to pay accountants or that it is unable to provide full and proper financial information to enable accounts to be prepared.
Multiple resignations at the same time might indicate a wish not to be associated with a failing company, or disagreement within the company about a course of action and fear of personal liability for the consequences if still in office.
Who is lending to that company?
Some lenders only operate in the “sub-prime” or “lender of last resort” market. A company using such a lender might suggest an urgent need for cash and that other routes are not open to it, or it has already been rejected by more risk-adverse lenders. Such borrowing often entails greater cost/repayments and might lead to cash flow pressures. The more frequent a company changes its lender, the more this might indicate that the company is having to source ever-more bespoke (and therefore expensive) finance to keep going.
Increasing payment days and surprise disputes
Is it taking longer than before for a customer to pay your invoices? Have you only been notified of a dispute after the invoice was due for payment and you have chased it? If so, this may indicate a tightening or restricting of cash flows. Being unable to pay debts as they fall due (where the debt is not genuinely disputed) is one of the tests of insolvency set out in the Insolvency Act 1986 and can trigger certain claims and actions.
Balance sheet blues
If the value of the company’s assets on its balance sheet is less than its liabilities (taking into account contingent and prospective liabilities), then the second insolvency test in the Insolvency Act 1986 can be established. This is because it is those assets that would be turned into cash in order to pay debts as at the date of those accounts. Consider whether this debt is due within 12 months of the date of the accounts or longer, and how the company is actually going to be able to pay the debt. This will be even more important if the company has made use of the Coronavirus Business Interruption Loan Scheme (CBILS) or the Bounce Back Loan Scheme (BBLS).
Increasing complaints from customers or clients for non-performance or poor service can be as a result of financial difficulty (e.g. reduced staffing, cheaper materials), and sometimes even the cause of it.
“People don’t rent videos anymore”
Remember Blockbuster and renting the latest film on VHS, and then DVD for the weekend? That all worked well, until Netflix came along. There are many examples where a change in the market or buying habits, and failing to meet those changes or adapt, will lead to a terminal decline in a business’s fortunes. This could be a longer-term indicator of the prospect of financial distress if sales revenues continue to fall.
Although a company exhibiting some of these signs might not constitute a trading risk at all, the more of these signs that are present at the same time, the greater the likelihood that the company in question is facing financial distress. As many of these signs can be picked up by publically available information, it can easily be incorporated into decision-making.
Andrew Knox is partner at Stephens Scown LLP, which has offices in Truro, St Austell and Exeter, and heads up the firm’s Insolvency and Restructuring practice area. Andrew can be contacted at firstname.lastname@example.org. For more information visit www.stephens-scown.co.uk