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How To Spot Early Signs Of Financial Distress For Your Business

Noticing the early warning signs of financial distress allows you to take action quickly, and potentially avoid insolvency. But when you’re caught up in day-to-day operational matters that constantly demand your attention, it can be difficult to recognise larger-scale issues.

Negative cash flow is typically the first sign that your business is struggling. In fact, this is a key problem as if insufficient cash is available to pay the bills, the business may not survive at all.

So what exactly should you look out for with regard to cash flow, and what other issues could indicate trouble ahead for your business?

Difficulty paying monthly bills on time

Hopefully, your business hasn’t reached the stage where it cannot afford to pay the bills as they fall due, as this is one of the signs of insolvency. If you’re ever worried that there won’t be enough cash to pay employees, suppliers, utilities or other regular creditors, it’s a sure sign the company is experiencing financial distress.

The best way to overcome this is to check how much cash you’re going to need over the coming months, updating this assessment daily if necessary. Regular cash flow forecasting indicates when a shortfall is likely, and allows you to seek additional funding or take other action to avert a cash crisis.

 

High levels of bad and doubtful debts

If your accounts show a significant amount of money that was owed to the business has been written off, or there’s doubt whether it will be paid, it’s an indication that your credit control procedures are ineffective. This can compromise your ability to bring in money efficiently and result in a slow decline over a longer period of time.

It’s possible that unrealistically high credit limits have been set for customers, or that you haven’t carried out credit-checks on new and existing customers. Or maybe there’s no effective system within the business for chasing payments.  

By improving your procedures, and invoicing customers as soon as work is complete rather than at the end of the month, you’ll find that cash flow becomes more fluid as working capital is naturally introduced into the business.

 

Pressure from your creditors

Experiencing unrelenting pressure and threats of legal action from your creditors, in the form of phone calls, emails and letters, is a sure sign that your business isn’t in the best financial health. 

Not only is it draining for you to constantly deal with this kind of pressure, but there’s a risk that legal action might be taken if a creditor has made several unsuccessful attempts to recover what is owed. This escalates your problems to a new level and threatens the existence of the business.

Inability to secure business borrowing

Maybe the borrowing facilities at your bank are always at the limit, or applications for business loans have been rejected by lenders? If so, this indicates your risk of default is too great for them to sanction lending. 

Lenders use a variety of criteria when assessing applications for borrowing, so it’s likely there are aspects of your business that have caused concern. It could be a decline in sales figures over a few months, for example, or a previous loan default, but being unable to obtain finance when you need it leaves you at risk of further financial decline.

 

Lack of reliable management information

Without accurate information on how your business is performing, and whether you’re meeting your ongoing liabilities, it’s easy for early financial distress to worsen. You need to know your figures if you’re to make confident business decisions day-to-day and in the longer-term, so it’s essential to have this information easily accessible. 

Whether you just need an upgrade to your current system, or you have to source new software, there’s an immediate benefit from having quick access to data such as sales and cash flow figures.  

 

Falling behind with HMRC liabilities

It’s a particularly dangerous situation for your business if you’ve fallen behind with HMRC payments. They have the power to wind-up up businesses quickly if they believe they’re insolvent.

You may be able to negotiate a Time to Pay (TTP) arrangement if you’ve had a good record of payment and submissions in the past, but it’s advisable to contact them as soon as you realise that a payment may be late.

 

Financial distress can occur very gradually in a business, insidiously compromising your ability to operate effectively and threatening success in the long-term. But being aware of the warning signs, such as poor cash flow and excessive bad debt, is incredibly beneficial. It allows you to rectify problems before they become unmanageable, and steer the business away from insolvency. 

 

Written by David Tattersall from Handpicked Accountants; David has more than 25 years’ experience advising UK business owners on a range of financial issues including insolvency, tax and raising finance.

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