Insolvency can have slightly different meanings depending on where you are in the world, but it generally refers to a company not having enough cash or assets to cover its debts and liabilities.
It goes without saying that this is a situation no organization wants to find itself in. Insolvency doesn't necessarily mean the end of the road for the business, but it can be an extremely difficult and stressful situation to manage, particularly for the finance team and all employees of the company.
You can minimize your risk of falling into insolvency by staying vigilant to warning signs that your balance sheet is tipping too far into the red.
1. Poor visibility over cash and accounts
One of the earliest warning signs that you could be at risk of insolvency in the future is if you have limited visibility over your accounts and the cash flowing in and out of the business.
Busy finance teams can become so preoccupied with the day-to-day activities and operations of the company that they lose sight of your overall financial health. This could leave you in a precarious situation, such as becoming overly reliant on account overdraft facilities or finance from creditors.
Having regular processes in place to monitor your accounts and stay up to date with your financial position is vital if you want to stay solvent.
2. Cash flow difficulties
Poor cash flow management significantly increases the likelihood that you'll fall into serious financial difficulties when the business encounters adversity. A company that loses a major customer or finds itself facing higher debt repayments because of interest rate changes, for example, could struggle if it doesn't have cash reserves to fall back on.
If you start to encounter consistent cash flow difficulties, it might be a warning sign that the business is falling into a dangerous spiral of diminishing assets and escalating liabilities. This might be temporarily addressed through borrowing or directors investing some of their own money into the business, but you also need to identify the underlying causes of your cash flow problems and address them.
3. Shrinking margins
The most accurate indicator of your company's financial health at any point in time is your profit, not your turnover. Making sales and keeping revenue flowing is of course important, but the amount you have coming into the business doesn't have much relevance until it's compared to your costs and expenditure.
If your profit margins are shrinking despite consistent or increasing revenue, you need to get your outgoings under control, rethink your prices or both.
Narrow margins mean you don't have the financial insulation to protect the business from shocks like sudden increases in costs or drops in demand as a result of economic conditions. This could be the start of a slippery slope that leads to insolvency.
4. Late payments to creditors
Payments due to creditors are often among the first financial obligations that fall by the wayside when a business starts to worry about its solvency and has to prioritize where its money is being spent.
Creditors won't be shy in letting you know that you've missed a payment deadline. If this is happening more and more frequently, it could be because the amounts you owe are steadily increasing (especially if you're borrowing to cover debts), while your income is staying the same or shrinking.
This is a clear red flag that your finances are moving in the wrong direction.
5. Threats of fines or legal action
If unpaid bills and late payments to creditors are becoming a common occurrence in your business, it won't be long before you find yourself facing threats of financial penalties or legal action.
This might be the shock that's required to instigate significant change in how the company manages its finances and uses the resources at its disposal, especially if the threat comes from a vital creditor or a tax authority.
6. Difficulties covering operating costs and paying staff
Keeping up with your financial obligations to external creditors is crucial, but it's just as important to make sure your staff are being paid in full and on time. Properly remunerating your employees needs to be a priority, along with covering basic operating costs to keep your core business running.
When these fundamental aspects of company management start to suffer, you need to carry out a thorough inspection of your fiscal situation and think about what action you might need to take, like restructuring your finances.
An increase in complaints from employees whose paychecks are late or inaccurate is one of the most obvious signs that you're struggling to cover your payroll costs. In this scenario, it's not just the company's financial circumstances that you need to think about, but fair and ethical treatment of your workforce as well. It's therefore crucial to ensure the situation is managed in the right way.