8 signs that a small business may be approaching insolvency

Although it does not necessarily herald the end of a small business, the decline into insolvency can bring significant changes in company structure, operations and management style.

Here are 8 early warning signs that indicate your small business could be heading for financial trouble, and the actions you can take to overcome them.

1. Inability to meet liabilities as they fall due

Regular and persistent communications from creditors in the form of phone calls, threatening letters and Statutory Demands for payment, signal serious cash flow problems for any business. You’ll be aware of a growing threat, even if you don’t know exactly how serious the problem has become.

Ignoring this type of communication is not an option, particularly if the creditor happens to be HMRC or your bank. HMRC in particular, are not slow in taking action and do not relinquish their rights to recover what is owed.

What you can do

Respond quickly to all creditors, as extended payment terms may be an option. HMRC operates a Time to Pay arrangement which could allow you to pay tax arrears over a longer period, generally three to six months.

2. No ‘Aged Debtors’ report

An ‘Aged Debtors’ report lets you know the details of all monies owed to the company, including:

  • Which customers owe you money
  • The total and monthly amounts
  • How long these debts have been outstanding

In general terms, a high number of ‘aged’ debts, or those debts outstanding for more than 30 days, is a strong indication that your collection procedures are inefficient.

Exceptions to this do occur in some industries, but allowing debts to remain unpaid for long periods of time, in conjunction with threatening communications from creditors, is a clear sign of serious problems.

What you can do

Use an Aged Debtors report to establish the efficiency of collection procedures in your business, and identify/deal with persistent late payers.

You can make it easier for customers to pay by including links in your invoices to electronic payment facilities such as PayPal.

3. You’re constantly dealing with problems

Despite devoting most of your day to problem-solving, it feels like you are not achieving anything. When one issue is solved only to be replaced by another, it’s time to take stock and look at the overall state of your business.

It’s very easy to get caught up in micro-management, and it might simply be a case of ‘not seeing the wood for the trees,’ but problems that are never truly resolved indicate strongly that your business is struggling.

What you can do

Take a step back to see if there’s a pattern, or area where problems are surfacing. Are they connected to one department or function of the business? Ask for professional advice from your accountant or an insolvency expert.

4. Insufficient information makes it difficult to see the ‘big picture’

If you cannot pinpoint the source of your problems, a lack of reliable business data may be hampering your efforts to improve the company’s fortunes.

Without detailed accounting information, or even basic details about how much you owe and how much is owed to you, it’s unlikely that cash flow problems will ever be brought under control.

The availability of reliable facts and figures can be the starting point for recovery. Lack of such information severely limits your understanding of the situation, however, and therefore your ability to deal with it.

What you can do

Set up a computerised bookkeeping or accounting package that produces detailed management reports. You’ll be able to view daily reports on your cash position, see whether you need to borrow money in the coming months, and know which customers pay late.

ByteStart’s guide on How to choose the best online accounting software for your business will help you find a good accounts package to do this.

5. No systems for staff to follow

With no formal procedures in place, particularly in the finance function, it’s possible that staff are not chasing payments consistently. They need guidance on how and when to communicate with late payers, whether to speak to them on the phone or use written reminders.

If there’s no set policy on when to apply strict credit limits, or whether to warn customers that you’ll claim interest on outstanding amounts, your business is not operating on solid foundations.

What you can do

Develop a strong credit control policy that includes strict limits for granting credit, and payment times that are clearly displayed on invoices and reminders.

6. Holding excessive levels of stock

Purchasing too much stock needlessly uses up working capital. Should it linger on the shelves, its value will also decrease.

Shifts in market demand leave you vulnerable to losses if too much inventory is held. Reviewing your purchasing procedures will free up more cash to pay suppliers.

What you can do

Setting up a computerised system of stock control keeps track of stock levels and lets you know when to purchase more.

7. Customers are regularly allowed to exceed their credit limits

If customers go over their credit limit on a regular basis as well as failing to pay on time, it makes your financial position untenable in the long term.

Lack of strict credit control policies when you take on a new customer may be at the centre of your financial problems, but it also applies to existing debtors.

What you can do

Set strict limits on credit for new customers and those who have a history of late payment, but don’t forget existing customers, even if they pay on time.

The information gleaned from a regular credit check will help you spot downturns in their business, which could ultimately have an adverse effect on yours.

8. Approaching numerous suppliers to get more credit

If you’re using an ever-increasing number of suppliers to spread the financial load, or because you don’t have access to other credit, it’s a strong sign that the business is in trouble.

Take time to reassess your cash situation, and look long and hard at the company’s performance.

What you can do

Approach your accountant for help in reviewing your cash situation. Either formulate a plan of action together, or seek the services of a professional insolvency practitioner.

Acknowledging that a problem exists is the first step to improving the situation, but it can also be the most difficult.

This guide was written for ByteStart by Keith Tully, a leading corporate insolvency specialist with Real Business Rescue. He knows what it takes to keep struggling businesses afloat and what qualities are required of company directors.

Last updated - 17th April, 2015

Bytestart Limited info@ByteStart.co.uk