Warning signs of a business facing financial distress

Warning signs of a business facing financial distress

Surprisingly, company decision makers and leadership don’t always have a true or realistic sense of the how the business is performing. This could be because they’re ignoring the situation, hoping it’ll just go away, or because they don’t know how to recognize the warning signs of a business facing financial distress. The first thing any company owner, or management team, must do is acknowledge there is a problem.  Trying to solve it themselves is not a good idea. The best thing to do would be to get an external opinion on exactly where the company’s finances stand and what the ramifications of that will be if nothing is done to reverse the situation. A successful turnaround plan relies on management having a realistic understanding of the real issues facing the business.

The list of early warning indicators

When there is insufficient working capital, a business quickly becomes cash strapped and unable to meet all, or some, of its monthly commitments, or to fund the day to day operations. Cash flow constraints can happen for a number of reasons:

Debtors Inadequate collection procedures and controls of money owed to the distressed company, which results in an increasing aging of outstanding amounts.
Factoring, selling debts to a third party, to raise immediate cash.
A failure to determine the credit worthiness of clients and then providing credit to high risk clients.
Unrecoverable debts owed to the distressed company by outside parties and the potential write off of these bad debts.
Creditors – Suppliers Creditors have stopped supplying services or products to the distressed company on credit terms and are insistent on COD.
The distressed company has outstanding debts owed to their creditors that go beyond their trading terms
and are increasing.
The distressed company having to pay their debts via Paid-in-part payments.
Special arrangements with certain creditors – acknowledgement of debt and monthly payment terms.
Letters of demand pending legal action and summonses being issued by creditors to the company.
Bank and financiers Overdraft at limit or at times in excess – special arrangements to meet commitments made.
Cheques and debit orders being returned.
Increased monitoring by the bank and demands for a reduction and/or cancelling facilities.
Breach and default in terms and conditions of loan agreements.
Profitability Recurring trading losses over extended periods of time due to chasing turnover and not determining if viable, margins are very low.
Inadequate costing systems.
Ever increasing overhead costs and no control over expenditure.
Tax issues Non/late lodgement of VAT and other statutory returns. PAYE, UIF and SDL are not paid on time.
SARS issues Director Penalty Notice on Director’s home address, rendering the director personally liable.
Company has entered into repayment
arrangement with SARS.
Tax clearance certificates have been cancelled due to non-compliance.
Accounting records Poorly compiled or non-existent.
Even if they are available, the financial statements are not reviewed and analysed by the management or business owners.
No cash flow and/or budget forecasting done.
Auditors’ fees are unpaid.
Monthly overheads Expenses such as rental, insurance premiums and other obligations are not met and are in arrears.
Struggling to find cash to pay salaries on a monthly basis or paying employees late.
Shareholders No support is given by the shareholders either by not providing further funding or by providing access to finance.
The shareholders aren’t involved and unaware of performance of their investments until it’s too late.

If these conditions persist then immediate action needs to be taken.  Avoiding the situation or pretending it doesn’t exist will be catastrophic. Cash flow problems are often symptomatic of more fundamental problems in the business, ones that need to be rectified. The consequences of business failure are painful and can cause unnecessary stress and strife for the management and employees of the business.