No director sets out to see their business become insolvent. However, it can and does happen. The company liquidation rate in the 12 months to July 2024 was 56.6 per 10,000 companies, or 1 in every 177 companies registered in England and Wales. The most vulnerable industries to liquidation were construction, wholesale and resale trade and repair of vehicles and hospitality. When it comes to new businesses, almost 20% fail in their first year. To avoid business insolvency, directors must be vigilant about what is happening across their business and take proactive steps to protect and promote the organisation’s financial health.
What are the Early Warning Signs of Insolvency?
Business insolvency does not happen without warning, unless an unexpected disaster occurs; for example, a catastrophic fire destroys all your stock, and you do not have adequate insurance. Signs your organisation’s financial health is in jeopardy include:
- The company cannot pay invoices on the due date. This indicates a risk of cash flow insolvency.
- Further credit is refused, and creditors are pressuring you to pay outstanding invoices.
- The company applies for a director pay freeze.
- As a director, you are dipping into your personal funds to pay company overheads.
- HMRC is chasing unpaid tax.
- Poor KPIs
- The company cannot pay employees.
- Everyone in the company senses something is wrong, leading to a stressful and unhappy atmosphere.
Five Practical Steps to Avoid Insolvency
Mitigating the risk of insolvency means proactively monitoring the following areas of the business and taking appropriate action to improve things if signs of financial ill-health occur:
1. Cash Flow Management
Cash flow is the money that comes in and out of the company. Part of cashflow management is to create an annual cashflow forecast to help you plan your business to ensure there is enough cash available month on month to cover expenses such as wages, suppliers, rent, utilities etc. A cash flow forecast can also help you, as a director, understand what opportunities you can take advantage of and when, for example:
- When you can afford to take on new employees
- The right time to invest in a new product or market
- Dividend payments
2. Reducing Business Costs
Business overheads can quickly get out of control if they are not monitored regularly. It is crucial to keep an eye on supplier costs, especially in cases where you have a contract that automatically renews with an uplift.
One way to reduce business costs is to keep track of wastage and eliminate any expenses that are not needed, for example, subscriptions to trade journals for industries you no longer supply to. In addition, undertaking regular employee rightsizing exercises will help ensure you have the right number of staff who possess the required skills needed for your company to reach its KPIs. Outsourcing certain activities, such as cleaning, maintenance, or IT support, allows businesses to lower expenses and gives the company greater flexibility in managing service levels as the business changes over time.
3. Diversify Your Revenue Streams and Customer Base
Forgive the cliché, but ‘don’t put your eggs in one basket’ is crucial for mitigating the risk of company insolvency. If possible, create a strategy that ensures your company has several distinct types of products and services to offer and a wide range of customers. The latter is particularly important, especially for smaller, younger businesses that often rely on one customer for most of their revenue. If that customer becomes insolvent or decides to drop your services/product, your cash flow will rapidly dry up, leaving you unable to pay your creditors. It is better to have multiple customers paying less, so if you lose one, replacing them is merely a challenge rather than a crisis.
4. Renegotiate Payment Terms
All businesses fall on tough times. If you are struggling, reach out to your suppliers and be honest. Remember, they have a much better chance of getting paid if your company remains solvent, especially if they are unsecured creditors. It is in their best interests to renegotiate payment terms if you need to create some breathing space to shore up your cash flow.
5. Know When to Get Expert Advice
Sometimes, despite your and your team’s best efforts, a company’s financial peril becomes too difficult to ignore, and uncomfortable decisions must be taken to ensure you are complying with your statutory directors’ duties. Once it becomes clear that the company will become insolvent, directors must act in the best interests of the company’s creditors. Failing to do this could result in you and other directors committing wrongful trading.
As soon as you realise there is a real risk of insolvency, you must seek expert legal and financial advice. An Insolvency Law Solicitor can advise you on the steps the Board must take to protect creditors’ best interests. They can also support you in understanding and implementing the best strategy regarding the next steps to take, for example whether to appoint an Administrator or propose a Company Voluntary Arrangement (CVA).
Avoiding Insolvency
There are many things you can do to avoid business insolvency – this article discusses only a few of them. Other good practices include having a detailed and up-to-date business plan, restructuring business debt, and monitoring the financial health of your organisation’s debtors.
If you are worried or need advice on how to respond to a growing risk of insolvency, please do not hesitate to reach out to us. As experts in insolvency law, we can provide advice and representation on all insolvency matters. Contact us on 0330 173 6983 or send us an email for more information.
