No one goes into business expecting to fail, although sometimes business owners lose sight of fundamentals such as ensuring the business is sufficiently profitable. It is very easy to chase turnover or a client which could be a game changer, only to run into working capital issues.

‘Turnover is vanity, profit is sanity’ may be a cliché but that does not mean it is not true.

Cash rarely flows in a steady stream and costs can rise sharply and unexpectedly, leading to issues managing liquidity (the ability to access funds to meet outgoings). It might be surprising to be told this, but Insolvency Practitioners (IPs) often hear “I wish I had spoken to you sooner.” 

From our side we invariably recognise points in a trading history or accounting records where either too little action or the wrong action was taken, or business owners and/or managers failed to recognise that they needed to act.

This article is about recognising issues early and seeking the right advice, from the right professionals at the right time.  A useful tool to consider is the Decline and Recovery Curve – a seven stage process which I have outlined below.

Put simply as liquidity worsens and issues remain unaddressed, the likelihood of formal insolvency significantly increases. It is sad to say that IPs are very often consulted when many turnaround options have been lost and the only options are formal insolvency processes.

Growth

It seems counter-intuitive to think about failure at a time of growth, but periods of growth are often a busy time for IPs.  This is particularly true during recovery from recessions.  Poor management systems and financial discipline can result in liquidity issues, cash flow pinch points and even crises. 

During a growth period there will often be temptations to take orders without sufficient working capital to fulfil them.  This is known as overtrading.  Payment of suppliers on worse terms than customers pay on, or delays on being paid from each customer order can lead to a worse short-term position.

Successful businesses invariably generate timely and accurate management information.  Depending on the business this could be a fully integrated 13 week rolling cash flow reviewed on a daily basis, to a cash flow reviewed on a monthly or even quarterly basis.  Some form of cash flow is vital, even if it is fairly basic.  The managers must also understand what their key metrics are and accurately measure the business’ performance against these as often as is appropriate.

Any gap in cash flow must be filled by credit, securing quicker payments, debt or investment.

Underperformance

Underperformance can be difficult to define and spot, but the key symptoms of this include lower profit margins and the cost of production or overheads increasing faster than revenues.

It’s important to ask tough questions and act early – this is not an easy process, and an IP can assist in identifying and addressing the root causes.

Distress

If no action is taken to combat a business’ financial problems, then this underperformance can turn into financial distress.  Insolvency is still not certain at this stage, but it is becoming more likely that some form of external agency will be required – by this time it is likely that an IP will be restricted in the options they will be able to recommend.

If your business is showing any of these symptoms, then seek advice from an IP:

  1. Cash flow – cash is king and constant lack of cash indicates a business is in trouble.
  2. High interest payments – lenders price according to risk and if a business’ cost of borrowing is increasing that means its creditworthiness is declining.  Personal guarantees may also be requested, and stronger security required.
  3. Defaulting on bills – if this is happening frequently it suggests a business cannot pay its way.
  4. Extended debtor or creditor days – converting debtors into cash is key to any business and failing to do this impacts cash flow.  Stretching creditors can ease cash flow but it is risky. 
  5. Falling margins – all that matters is profit and if margins are falling it indicates costs are too high and prices or income are too low.
  6. Unhappiness – high staff and/or management turnover.

Crisis

A business that ignores signs of distress will eventually hit crisis point, and although an insolvency process is likely to be the only way out at this stage, there are still ways of saving the business with the technical expertise of an IP.

Here is a flavour of the different insolvency processes available:

  1. Company Voluntary Arrangement – Allows a company to enter into an agreement with its creditors to repay its debts or a percentage of them.  The directors retain control of the company with the IP supervising the arrangement and ensuring its terms are adhered to.
  2. Administration – A rescue procedure with the required hierarchy of objectives to rescue, achieve a better result than a liquidation or sell assets and pay distributions to secured and/or preferential creditors. An IP can give advice to the company or a major creditor of the company prior to appointment. Pre-pack administration refers to the sale of a business negotiated prior to appointment.  The sale is then completed upon appointment. In a pre-pack administration the administrator is required to send an explanation of why the pre-pack was appropriate to the creditors shortly after appointment.
  3. Receivership – An IP (or other suitable individual) is appointed to sell secured assets to repay a lender. An IP can advise the lender prior to appointment.
  4. Liquidation – Assets sold by IP acting as the liquidator who then pays creditors in an order set by the law. Compulsory liquidation is a court process and usually it is instigated by a creditor. Creditors voluntary liquidation is a process instigated by the directors of the company and controlled by the shareholders, although the choice of liquidator must be ratified by the creditors of the company. Members voluntary liquidation is for a company that can pay all debts together with statutory interest.

Crisis Management

This is the stage where a business owner must decide to save the business or shut it down – IPs will have been faced with this situation many times and can help to manage either process by going through a formal, legal procedure.   Should trade continue one of the most immediate priorities will be to reduce costs while maximising income.  Once an insolvency is certain and the directors have realised this, it is the directors’ duties to protect the financial position of the business’ creditors rather than the interests of the company and its shareholders.

Stabilisation

If a business has emerged from a Pre-Pack Administration or a Company Voluntary Arrangement, it is at this point that the business owners must get instil the right fundamentals when manging their business, including analysing data and other information at their disposal. This is what should have happened at the launch of the business.

Recovery

The final stage is recovery and by continuing to get the fundamentals right a business can generate profitability and sustainable growth.

Summary

There really is no such thing as taking advice too early and the earlier the advice is taken the more options there are.  Having said that though, it really is never too late either and having an IP advising in a crisis is exactly what a business needs. 

Tom Gardiner, Associate Director, CVR Global