Recognising the early signs that one of your suppliers might be at threat of insolvency could help to safeguard your own business against financial risk.

At this difficult time, no business wants to think about its suppliers or customers going under, and an invitation to take part in a creditors’ decision-making process for an insolvency procedure can come as an unwelcome surprise. However, this is not the only way to spot a company in financial difficulty and here are some early warning signs that we have seen distressed companies exhibit.

Reading the signs early and acting appropriately could reduce the number of creditor invitations you receive, and help prevent your own financial difficulties.

Signs that a business may be at risk of insolvency

Legal action by creditors

Given that legal action can increase the amount needed to be paid (because the creditor may be able to recover their legal costs from the debtor and be entitled to claim interest at 8%), most businesses tend to try and avoid matters getting to this stage.

If a company has a number of unsatisfied judgments against it and the frequency and amounts of the judgments are increasing, this suggests the company is struggling to pay in full and on time.

Late or non-filing of company accounts

Late filing might be due to a valid reason unrelated to the company’s finances. However, a common reason can be the firm’s lack of money to pay accountants or that it is unable to provide full and proper financial information to enable accounts to be prepared. Running a company without accounts/financial information is like driving a car with your eyes closed.

Director resignations

Multiple resignations at the same time can be common in the event of a share sale or retirement due to succession in a family-owned company. However, it can also indicate a wish not to be associated with a failing company, or disagreement within the company about a course of action and fear of personal liability for the consequences if still in office.

Who is lending to that company?

Some lenders only operate in the “sub-prime” or “lender of last resort” market. A company using such a lender might suggest an urgent need for cash and other routes are not open to it, or it has already been rejected by more risk-adverse lenders. Such borrowing often entails greater cost/repayments and might lead to cash flow pressures. The more frequent a company changes its lender, the more this might indicate that the company is having to source ever-more bespoke (and therefore expensive) finance to keep going.

Increasing payment days and surprise disputes

Is it taking longer than before for a customer to pay your invoices? Have you only been notified of a dispute after the invoice was due for payment and you have chased it? If so, this may indicate a tightening or restricting of cash flows. Being unable to pay debts as they fall due (where the debt is not genuinely disputed) is one of the tests of insolvency set out in the Insolvency Act 1986 and can trigger certain claims and actions.

Balance sheet blues

If the value of the company’s assets on its balance sheet is less than its liabilities (taking into account contingent and prospective liabilities) then the second insolvency test in the Insolvency Act 1986 can be established. This is because it is those assets that would be turned into cash in order to pay debts as at the date of those accounts.

Consider whether this debt is due within 12 months of the date of the accounts or longer, and in any event, consider how the company is actually going to be able to pay the debt. This will be even more important if the company has made use of the Coronavirus Business Interruption Loan Scheme (CBILS) or the Bounce Back Loan Scheme (BBLS).

Bad reputation?

Increasing complaints from customers or clients for non-performance or poor service can be as a result of financial difficulty (e.g. reduced staffing, cheaper materials), and sometimes even the cause of it.

“People don’t rent videos anymore”

Remember Blockbuster and renting the latest film on VHS, and then DVD for the weekend? That all worked well, until Netflix came along. There are many examples where a change in the market or buying habits, and failing to meet those changes or adapt, will lead to a terminal decline in the fortunes of a business. This could be a longer-term indicator of the prospect of financial distress if sales revenues continue to fall.

Some of the above signs are stronger indicators of financial distress than others, whereas a company exhibiting some signs might not constitute a trading risk at all. The key thing is to be alive to them, and as many of these signs can be picked up from information that is publically available, it can easily be incorporated into decision making. However, the more of these signs that are present at the same time, the greater the likelihood that the company in question is facing financial distress.

For more reading, we’ve shared some of the most common questions about insolvency and bankruptcy here.