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.
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.
The Prognosis for Unsecured Creditors
In an insolvency situation, an insolvency practitioner (IP) is appointed to maximise the returns for company creditors. These creditors include banks, suppliers, employers, HMRC and other businesses. In an insolvency situation, there is rarely enough money to pay all the creditors who are left out of pocket.
For this reason, IPs must follow a strict priority order, set down by statute, which dictates who gets paid what. As a company that has provided goods or services to the insolvent organisation, you are classed as an unsecured creditor. Unfortunately, unsecured creditors are well down the pecking order, which means you’re unlikely to receive much, or any of the money you are owed.
The priority order is as follows:
1. Chargeholders – those with a legal right or ‘charge’ over company property
2. The fees and charges of the insolvency practitioner
3. Preferential creditors – i.e. unpaid wages, pension contributions and holiday pay
4. Creditors holding a floating charge over an asset – i.e. debentures
5. Unsecured creditors – including HMRC and other trade creditors
6. Interest payable on debts
The warning signs of a struggling customer
Businesses do not become insolvent overnight. 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
It’s no exaggeration to say that dealing with insolvent customers is one of the biggest challenges your company will face. 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.
How can we help?
Want to discuss your cashflow problems or invoice finance options with an expert business debt advisor? Please call our UK Directors Helpline on 08000 746 757 for the free advice and assistance you need.