The cost-of-living crisis means businesses have less cash on hand, putting them at risk of insolvency — a company becomes insolvent when it is unable to meet its financial commitments due to a shortage of cash, or when the total value of its assets is less than the money it owes any creditors. Here we explore the early warning signs of insolvency.
No money to pay staff wages
A key sign that insolvency is looming over your business is that you’re struggling to find the cash to pay wages. Another is that you as the founder have not taken a salary for a few months. Does the following sound familiar? “We just need to wait for the next big sale.” If it does, you’re probably close to insolvency. Remember, once an employee’s wages go unpaid, your company is technically insolvent.
A negative liquidity ratio
Measuring a company’s ability to satisfy its current liabilities from its assets is the essence of the liquidity ratio. A liquidity ratio below 1 means that the company does not have sufficient assets to meet its current liabilities. The liquidity ratio is a good indicator of insolvency, but it must be judged against a company’s access to alternative finance.
Inability to obtain finance
Lenders have many tools to judge whether a business is worth backing. So, if shareholders, investors, banks, or other lenders refuse to provide financing, it may indicate doubt around profitability or long-term prospect of success. Once again, this measure must not be viewed alone. Remember, in times of crises, lenders are often more risk-averse and more likely to take a wait-and-see attitude to investment and lending opportunities.
High staff turnover
Businesses in distress often struggle to retain staff. It might be that your employees see a problem you don’t. Have they seen the writing on the wall? Replacing staff is time-consuming and costly, and new staff prone to errors and reduced efficiency.
Creditor Action
Most businesses miss payments from time to time. However, County Court Judgements (CCJs) should be a warning sign that sets the alarm bells ringing. A company that settles CCJs within 30 days and it won’t be held on their records. The moment you do get a CCJ, suppliers will see it as a big red flag. Credit reports will issue warning on credit reports to highlight this warning sign.
Falling margins
Falling margins suggest that business costs are too high and income is too low. Remember that a sustainable business cannot survive under those conditions. Many businesses in this position will often look to reduce prices to increase sales when cost-cutting measures may be more appropriate.
Decline in reputation and market position
It’s common for a failing business to experience a reputation hit. This may prompt customers to look elsewhere. Another common approach to repair reputation is to relaunch or rebrand the business. Is there a purpose here that lines up with new brands or products that would improve the business, or is it an exercise in lifting flagging performance? The latter is a sign that insolvency is on the horizon.
High-interest payments
If your bank offers you above average interest rates when trying to access a business loan, it’s likely they are concerned about the health of your business and treating it with caution. Increased borrowing costs can exacerbate an already difficult situation. Thankfully, there are more borrowing options than ever, but proceed with caution and make sure you believe in the future of your business before taking on additional loans.
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