The road to insolvency is often signposted by red flags and warning signs to indicate danger is fast approaching. Once a financially distressed company takes a turn for the worst, the company director will find themself at a crossroads with one momentous decision to make – to seek help or risk becoming insolvent. If the director fails to provide direction and navigate the business out of financial difficulty, it will eventually run out of fuel and the damage will be fatal.
The telltale signs of company insolvency are often visible from an early stage. Company directors must heed the warnings, as once the company reaches a terminal state, the chances of recovery will be low. The journey to insolvency is testing for company directors as they come up against borrowing tight spots, trading uncertainty and severe financial difficulty.
Chelsea Williams, a corporate insolvency specialist at Scotland Liquidators, handpicks key warning signs that indicate company insolvency is fast approaching.
The early warning signs of insolvency are often dismissed by company directors as they are mistaken for teething problems likely to be short lived, rather than signs that a business is approaching death’s door.
A business with a basic support team, such as a proactive company director and a knowledgeable accountant will have the tools to monitor business health and raise the alarm if company insolvency is on the horizon. Paired with an understanding of the warning signs of insolvency, business owners can turn around the fortunes of their business.
Once a lender determines that a borrower has reached maximum debt capacity, they will reject applications for further borrowing, including overdraft or credit limit extensions. If this was the only remaining lifeline for the business, insolvency may be fast approaching if a solution is not sought.
Creditor pressure can range in severity, from courtesy payment reminders to threats of legal action. While a creditor can seek a winding up petition if they suspect that a debtor is insolvent, the impact may be amplified, such as hostility or an indefinite breakdown of the professional relationship.
A creditor may seek legal action as a final resort if they suspect a debtor is insolvent. After numerous unsuccessful attempts to collect overdue debts, creditors may seek a winding up petition. If a winding up petition is granted by the court, the creditor may likely see returns in part or in full as part of the compulsory liquidation process.
If there is dangerously limited cash in the business, this will trigger a cycle of financial difficulty which will leave the director unable to cover essential outgoings, pay staff wages and keep the company operational. An asset rich, yet cash poor business may offload assets to release cash in the business, however, if there is substantial debt, the business may require professional restructuring support.
The balance sheet and cash flow tests provide a window into the financial health of a business and are essential tools used to check whether a company is insolvent.
The balance sheet test checks whether the value of company liabilities overtakes that of company assets, while the cash flow test searches for overwhelming discrepancies between expenditure and income. Both tests collectively paint a picture of the financial health of a business and indicate the speed at which insolvency is approaching.
A company is deemed insolvent once it cannot fund liabilities as and when they fall due. If a company director suspects that the business is on track to becoming insolvent, professional insolvency guidance must be sought at the earliest opportunity. If there’s a possibility the business can be rescued, a licensed insolvency practitioner will set out to diagnose the problem, the causes and devise a solution that can secure a future for the business.
This blog explores how effective due diligence and credit risk management can protect businesses from financial risk, late payments, and cash flow crises.
Begbies Traynor share expert insights on business and credit risk in this guest article, offering powerful advice from the UK’s top insolvency practice.
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