We explain how to reduce your company’s risk of insolvency, as well as the warning signs to look out for.
You can minimise your exposure to risk via practical business management strategies, as well as decisive action when tough decisions are called for.
What is Insolvency Risk?
Before we begin, let’s clarify what the definition of insolvency is. From an accounting perspective, a company is insolvent when it can:
(a) not pay its bills when they fall due
(b) when liabilities exceed assets
In practical terms, any business needs enough cash flow to meet its obligations. So the closer you are to not being able to do this, the higher your risks of insolvency.
Late Invoices Trigger Insolvency Risks
Having key customers that are struggling financially is one of the leading causes of company insolvency in the UK. This is particularly the case for smaller companies that tend to rely heavily on one or two major customers. They also lack the financial reserves of bigger businesses and find it more difficult to source finance from banks due to the lack of available security.
The result is that other company’s cashflow problems can quickly create a crisis that, at worst, could lead to the failure of your business. For this reason, it’s essential you do everything you can to limit your business’s exposure to these risks.
Improving Cash Flow
Similarly, anything which benefits the cash-flow cycle is going to lower your overall risk of insolvency. You can do this by:
- Invoicing more efficiently
- Holding Less Stock
- Accurate cash-flow forecasting
- Using Invoice Finance
It stands to reason that spending less is going to positively impact available cash. Here are some strategies for doing that:
Reducing Business Expenses
- Lease rather than buy business equipment
- Push your suppliers for the best deals or shop around
- Embrace technology and automation
- Implement a strict business budget
- Save on wages by outsourcing some work
- Eliminate inefficiency
- Use teleconferencing as an alternative to expensive corporate travel
Notice the Warning Signs of a Struggling Customer
Being aware of when a key customer may run into insolvency issues is one way of protecting yourself. It’s no exaggeration to say that dealing with insolvent customers is one of the biggest challenges your company will face, with the recent Carillion fiasco demonstrating the power of the domino affect.
Businesses do not become insolvent overnight. of course. Typically, there are a number of insolvency warning signs that are indicative of a company that’s struggling financially. Companies in financial distress usually live a hand-to-mouth existence, paying their bills late or not at all. If you’re constantly chasing a customer for money, it could well be a sign of serious cashflow problems behind the scenes.
It also makes sense to keep up to date with the latest developments in your customers’ industries. If a business is failing, there’s likely to be news stories or speculation in the specialist press. Stories of firings or redundancies are potential red flags.
Reducing your Company’s Risk of Becoming Insolvent
To protect your business and mitigate this risk, there are a number of steps you should take:
• Credit check your customers – Checking the credit references of prospective trade debtors is an absolute must, particularly if they operate in an industry with a high failure rate. The highest failure rates are shown on page 10 of this official Insolvency Service release.
• Regularly review credit limits – Companies regularly extend their credit terms to secure new business and develop a good relationship with customers, but you should always keep a close eye on your credit limits.
• Implement credit control procedures – You should have a clear and effective credit control procedure you follow every time an account becomes overdue. This will help you identify your exposure at an early stage and act accordingly.
• Retention of title clauses – If appropriate, incorporate retention of title clauses in the terms of your customer contracts. This allows you to seek recovery of your products in the event of non-payment.
• Explore credit insurance and invoice financing – A credit insurance policy will pay out and protect your business against a customer’s failure to pay. Alternatively, you might consider an invoice financing agreement, such as non-recourse factoring, which pays you a proportion of the value of an invoice upfront. This can help to protect your business from the impact of an insolvent customer.