Date posted: 8/07/2020 4 min read

Know the early warning signs of a business in trouble

Early identification of warning signs can give businesses the best chances of survival.

In Brief

  • Many business owners/directors may take a long time to accept that their business is in trouble and often ignore the early warning signs
  • Early identification of trouble and the engagement of insolvency experts can offer the best chances of survival
  • A CA can help by identifying early warning signs and suggesting corrective action

One of the most commonly cited reasons for a company’s failure is due to management, particularly in small businesses, where the business owners/directors have limited understanding of the obligations and, in many cases, limited education and/or experience in financial matters.

This is where Chartered Accountants can assist by identifying the warning signs early, suggesting corrective action to prevent business failure and offering timely advice.

The Australian Securities and Investments Commission (ASIC) reported in its summary of findings (ASIC’s Report 645 Insolvency statistics: External administrators’ reports (July 2018 – June 2019) (ASIC report) that 8089 companies lodged external administrators’ reports in 2018-19. Of these:

  • 85% had estimated assets of A$100,000 or less 
  • 38% had estimated liabilities of A$250,000 or less
  • 62% had an estimated deficiency of A$500,000 or less

The New Zealand Insolvency and Trustee service reported that in 2018-19, 49% of corporate insolvencies (administered by the Official Assignee) had total debt of more than NZ$100,000. These statistics show that a high proportion of businesses that fail are small.

Too often, business owners/directors take months or even years to realise that their business is in trouble and often ignore the early warning signs.

Causes of failure

It’s important to note that a changing business does not mean that it’s a failing business, and it is important for directors and management to constantly evaluate current business and economic conditions as well as the non-financial risks that may affect operations. 

A loss of a major customer, a new competitor, the business is growing too fast or it is outgrowing its founders’ know-how are examples of factors that could trigger early warning signs.

Current business and economic factors as a result of COVID-19 need to also be considered such as physical distancing implications potentially impacting sales and availability of sufficient cash for a business to maintain JobKeeper (AU) or wage subsidy (NZ) payments to staff.

The top three nominated causes of failure for businesses in ASIC’s report were:

  1. Inadequate cash flow or high cash use
  2. Poor strategic management of business
  3. Trading losses.

The New Zealand Insolvency and Trustee service reported that in 2018-19, the top three primary causes for corporate insolvencies were legal action, failure to provide for tax and inability to collect debts.

Seeking help early can save many businesses

A small regional not-for-profit residential aged care facility (the association) was recently saved from insolvency as it, together with its auditor, identified early warning signs of solvency problems. By engaging an insolvency practitioner as soon as the early warning signs were detected, the issues were identified quickly. 

The practitioner was then able to provide advice to the CEO and facilitate talks with a range of stakeholders (bankers, competitors and government) to monitor cash flow issues and identify a partner or transitioned ownership (in the short term) to an organisation that could restore profitability.

The association was able to transform and was saved from insolvency. This success story highlights the importance of identifying the early warning signs.

When detected early, a business has time to understand the cause of the problems and explore options for recovery, including non-formal insolvency options, relevant and targeted stakeholder identification and government support.

Early warning signs

Here are some of the early warning signs businesses (and those that advise them) should be watching for:

  • loss of a significant customer or supplier
  • forecast targets consistently missed
  • uninsured or unexpected disasters
  • failure to complete a transaction/divestment
  • time spent on a financial crisis is more than time spent managing the business
  • creditors placing the business on stop supply or requiring special payment terms (creditor payment arrangements)
  • missed payments to landlords
  • urgent requests for bank funding
  • increased intervention/pressure/oversight from banks or other financiers
  • shareholders regularly injecting money into the business
  • accounts payable days stretching over 45 days
  • superannuation obligations not being met
  • overdue tax lodgements, including overdue BAS statements
  • directors taking minimal to no wages
  • financials are not up to date or accurate
  • management inertia
  • low staff morale.

Business owners/directors should be able to identify the early warning signs if their business is in trouble. Early identification and engagement of experienced turnaround and insolvency experts can give businesses the best chances of survival. 

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