Dealing with financial problems

If a financial problem is allowed to get out of hand the results can be catastrophic, not only for the business owner, but also for staff, creditors and customers. It’s vital, therefore, that business owners remain alert to any sign of trouble.

In brief

• What kind of financial problem may occur?
• Warning signs
• Act sooner rather than later
• What should I do?
• Talking to your bank and investors
• Trading while insolvent
• Administration and voluntary arrangements
• What to do next

Every business that runs into trouble has its own story to tell, but there are a number of familiar scenarios. These include:

• Initial underfunding. This problem affects many start-ups. Most businesses require a certain amount of start-up funding to cover the cost of premises, staff and materials before sales revenues begin to build up. It’s easy to underestimate the cash required. Unless refinancing is an option, the business will be unsustainable
• Insufficient sales and/or inadequate profit margins. Essentially, if the company can’t sell enough products or if the profit margin sums don’t add up, it won’t be able to pay its way in the longer term
• Rapid but poorly planned growth. Rising order books or a move into a lucrative foreign market might seem a bonus, but growth can put real pressure on a business. For instance, a large order could mean investing in more staff or buying new equipment, long before the associated revenues come in
• Too much money tied up in non-liquid assets, such as stock or machinery, and not enough money available to fund trading
• Late payment by customers or poor invoicing and debt-chasing processes.

The common factor in all of the above scenarios is a shortage of available cash. In order to survive, the money coming into a business every month, plus any reserves and loan facilities must at least match your outgoings. Cashflow problems can afflict even those businesses that are doing well by other measures such as sales and margins. Lack of cashflow is the number one business killer.

Make forecasts for the months ahead, look at sales and expected cashflow. If sales or cashflow begin to fall below forecasts, you should take immediate action. Regularly ask yourself the following questions:

• Are sales falling?
• Are you losing market share?
• Is your reputation suffering when compared to your competitors?
• Are you being forced to borrow more in order to cover operational costs (rather than investment)?
• Is it becoming increasingly difficult to pay creditors?

If the warning signs are there, business owners must act quickly. Businesses that experience financial difficulties often find themselves on a downward curve. Initially, the problems may not seem serious. Sales may be slightly down. The cash coming into the business may not quite meet the outgoings. The business may respond by pushing its overdraft to the limit and delaying payments to suppliers for a few more days until the books balance. The business carries on as normal in the hope that next month’s cashflow and sales figures will improve.

However, if figures don’t improve the next stage can be full-blown panic. The current financial arrangements may not cover the deficit. At this point a business could find itself inundated with demands from suppliers and it may be difficult to pay staff.

If the problems aren’t resolved then the endgame can be insolvency, not the outcome anyone wants and one that could have been avoided had action been taken earlier. By this stage, business owners have virtually lost control. This is why the time to act is sooner rather than later. The key is to be pro-active with measures that will put your business back on an even keel.

By spotting the early warning signs, you will be in a much stronger position to put things right. Employ the solutions that are appropriate to your circumstances and the cause of the problem.

For instance, if your cashflow difficulties are related to sales figures, then a first step is to trade your way out of the problem. If the resources are available, step up your sales and marketing. Sell more to existing customers and tap into new markets.

If the time-delay between the raising of an invoice and the customer paying is causing cashflow problems, there are a number of possible solutions. These include:

• Focus on winning business that will generate cash quickly
• Tighten credit control. Make sure invoices are sent out on time. Chase payment when it becomes due
• Consider factoring or invoice discounting arrangements, where cash is lent to you by the bank as soon as an invoice is raised
• Keep track of the financial health of your customers and suppliers
• Change payment periods

If there is no real chance of sales improving, then you should consider other measures such as selling assets, cutting staff and reducing costs and/or inventory in order to free up cash.

Make the time to regularly talk to your bank. For instance, if your problems are caused by a lack of available finance due to overly rapid growth, a bank is more likely to provide the funds if the problem is identified early and brought to its attention. Similarly, the bank will be more willing to provide solutions such as invoice discounting if it’s clear that management has been quick to address a problem.

If your financial situation threatens your ability to meet existing repayment obligations, banks are more likely to be sympathetic if you talk to them early and present a credible business plan. Investors (if you have them) should also be kept aware of the situation.

The one thing you should never do is trade while insolvent. If the company runs out of cash, then it is illegal to take orders from customers or take goods on credit from suppliers. Business owners/directors face serious penalties if they break this rule. However, the definition of insolvency is complex and it’s not always easy to know when you’ve crossed the line. If in doubt, seek advice from your lawyer or accountant.

If you are insolvent, the next step may be administration, which will see accountants taking control. However, by acting early you can reduce the chances of this happening.

When faced with debts that can’t be paid, the endgame for many companies is administration. While this sounds drastic, it needn’t be the end of the road.

Under the recently enacted Enterprise Act, the accountants who take over the running of a company when it is put into administration have a duty to do all they can to return the business to operational health.

A change in the law removing the preferential rights of the taxman over assets has made this job easier. The company will only be liquidated – and all its assets sold to pay off creditors – when all other avenues have been exhausted.

Administration occurs when a company’s financial difficulties prompt creditors, stakeholders, or sometimes the directors themselves, to apply for a court order to begin the process.

A variation on the theme is administrative receivership. This occurs when a creditor or lender has a claim on the company’s assets to cover non-payment. In these cases the role of the receiver is to recover assets for that particular creditor.

Voluntary arrangements
One useful means of getting through a period of crisis is to reach a formal agreement with creditors under a Company Voluntary Arrangement (CVA). Under these agreements, creditors and the company agree a legally enforceable recovery plan. Once a CVA is in place, creditors can’t sue for repayment for an agreed period of time and the company has time to recover.

Similarly, sole traders with debts of less than £5000 can apply for an administration order, which will allow them to pay the courts an agreed monthly sum that will be divided among creditors.