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What are the most common signs of Insolvency?
There are a number of statutory definitions of insolvency. However, the two most relevant to those of us who deal with small owner managed businesses are:
- The value of assets of the business is less than the amount owed to creditors.
- The business cannot pay its creditors as and when they fall due.
Once a business is insolvent then that is when the owners, be they directors of a limited company or proprietors of a sole trader or partnership, really need to approach a licensed insolvency practitioner (an IP) for advice. However, an Insolvency Practitioner can be more helpful the sooner he is contacted because that may give more options to allow the business to be saved.
This list is not exhaustive and there may very well be signs of insolvency that have been omitted but what it does serve to do is to give an idea as to the financial wellbeing of a business. It will be noted that most of these are based on common sense rather than any clever piece of accounting. They are in no particular order, although an attempt has been made to group these signs of insolvency into categories.
- Overdraft is constantly at its limit. The owner has to ring the bank before payments can be made or has to ask for permission for essential payments, such as wages, to be cleared.
- The bank is blamed for not supporting the business.
- Dishonoured cheques.
- Bank charges becoming excessive
- The bank requests monthly management accounts
- The bank will not extend overdraft facilities and instead asks for the existing overdraft to be put on a loan with the business now operating in credit.
HMRC & Trade Creditors
- Payment plans have to be put in place with creditors.
- Payment plans are not adhered to.
- Arrears to HMRC for PAYE, VAT, Income Tax, and Corporation Tax build up as the business uses the Crown to provide funding for working capital that the Bank will not provide.
- County Court Summonses
- Bailiffs attending to levy distress on assets.
- Creditors ask for payments to be made before they will deliver goods.
- The business was started from the ashes of another failed business and too much money is being paid to the creditors of the former company ‘because I cannot trade without them’
Owners & Directors
- Directors continuing to take dividends as their wage because they do not wish to increase the debt due for PAYE
- Directors do not take a wage because the business is short of money
- The owner is having to pay for supplies on his credit card
- The owner is regularly introduces money into the business either from his own resources or from members of his family.
- The owner is under financial pressure personally which indicates that the business is unable to provide the level of income needed to support the standard of living required
- The owner is stressed and perhaps is more often absent from work or people cannot reach him or her as easily.
- The owner ignores good advice and seeks out those who will tell him or her that which they want to hear.
- The owner’s remuneration policy, be it wages, dividend or drawings is based on the amount of cash available rather than the financial obligations of the business.
Debtors & Sales
- In more serious cases there may be an increase in credit notes as invoices are issued earlier to get money in before the work is actually completed or goods delivered.
- If the debts are financed there may be a greater problem than usual with the invoice discounter who is finding that the debts upon which money has been advanced are not being paid. This then leads to a reduction of funds available to the business.
- The actual amount owed to the invoice finance company is significantly less than the theoretical percentage advance.
- The proportion of debtors to sales is increasing signifying either a reluctance to deal with bad debts, or that the business is unable to collect its debts within a reasonable period of time.
- Over reliance on one source of business
- Loss of a major source of business
- Debtors not paying or taking longer than usual to pay.
- Debtors using spurious reasons for the non-payment of sales invoices.
- The business starts quoting for work at or below cost just to keep some money coming in.
- Gross profit margins are being reduced as customers seek more competitive quotes.
- Assets (such as book debts and plant) have to be financed to provide working capital that is used to pay creditors rather than invest in production
- Finance agreements have to be renegotiated to reduce pressure on cash flow
- The value of stock or work-in-progress may be artificially high in the accounts to cover up the fact that the business has been suffering for some while.
- Post is left unopened.
- Phone calls from creditors are evaded.
- Unsolicited mail from ambulance chasers.
- The business is profitable but the profits made are not sufficient to meet its obligations because the business is over geared. This especially a problem where the company has a large amount of equipment on finance.
- The statutory accounts are not made up as the accountant has not been paid. The bookkeeper is let go because ‘I can do it myself’
- It is obvious that the workforce does not have enough to do.
There is a constant clamour in the media and from some politicians for banks to lend money to small businesses. This is not going to happen, because now the banks have to have regard for the ability of the business to repay them. In the recent past all that needed to happen for a bank to lend money was for the owner to guarantee the debt and give a charge on his house and the cash would magically appear. The ability of the business to repay was insufficiently considered, if it was considered at all. This has now changed to back where it should have been all along were the decision to lend is based not only on the level of security but also on the viability of the business. However, having said that, there appears to be a number of second tier lenders appearing in the market who are lending to businesses without properly looking at the affordability of the repayments.
HMRC ‘Time to Pay’ agreements have a fundamental flaw. They are predicated on the fact that the business is going through a small blip and whilst the debt cannot be paid now it can be paid in the future along with the current obligations. In small businesses this can be a false assumption because these businesses have to be making a large enough profit to be able to meet the obligations to the Crown.
Small businesses usually start because an owner has a particular skill to sell. That person does not always have all the other skills that are needed to run a business. On a fundamental level this means understanding the following:
- The need to keep proper books of account so that it should be comparatively easy to assess the financial status of the business.
- That book debts need to be collected as soon as possible and sales are worth nothing until the cash is received.
- The gross margin that the business makes; the level of turnover that is needed to break even; and therefore the maximum level of overhead that the business can support.
- Knowing the financial requirements of the business means that management is able to produce proper quotes for its customers.
- The fact that a business is profitable is not of itself the be all and end all because the profits need to be enough to cover any loans, finance agreements, and other funding obligations.
- Owners need to understand that there is no divine right to a certain standard of living and that money they withdraw from the business can only be what the business can afford.
Lines Henry is a firm of Licensed Insolvency Practitioners. Whilst we act as liquidators, administrators, trustees in bankruptcy, and supervisors of voluntary arrangements we also advise businesses on how they can avoid having to use our services. All initial meetings are free of charge and more often than not these are held at the business premises rather than our offices.