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Companies in Financial Distress: The Early Warning Signs

Posted: 22 Aug, 2022

Earlier this month, in the sixth consecutive hike since December, the Bank of England raised interest rates to 1.75% in an effort to bring inflation under control. Currently, it's predicted that inflation will peak at 13.3% in October and the economy will enter into a long recession at the end of the year.

Shortly after the Bank of England’s announcement, Begbies Traynor released its latest ‘Red Flag Alert’ report which revealed the effect that soaring inflation and the cost-of-living crisis is having on UK companies.

The report showed that almost 2,000 companies were in critical financial distress by the end of Q2 2022, a rise of 37% year-on-year. It also said that more than half a million companies, 582,000, were in significant financial distress.

Bars and restaurants, retailers and the construction sector are the major drivers behind the rise in companies in critical financial distress with year-on-year rises of 70%, 48% and 36% respectively.

The cause of financial distress is attributed to a combination of rising inflation, higher labour, material and energy costs and faltering consumer and business confidence. Add to that the fact that many businesses are also under pressure to pay back their Covid support loans and you can understand why so many are under significant financial strain.

Commenting on the report’s figures, Julie Palmer, partner at Begbies Traynor, said: “There are firms that are struggling to work out what they will do…many are fighting on, but the environment is only going to get worse, not better, at least until later next year or 2024. I fear that it may be a troublesome autumn as businesses which have struggled for so long are finally overwhelmed”.

Early Company Distress Warning Signs

While a company in critical or significant financial distress is likely to know they are in trouble, it is common for businesses to overlook the early warnings signs until it’s too late. But by identifying distress in its early days, actions can be taken to address the problems and takes steps to return the company to health.

For companies that want to be prepared, here are a few early warning signs that indicate there is a problem that needs to be addressed.

Poor cash flow

Poor cash flow is a problem that many businesses face in their lifecycle and if not corrected, can lead to their failure. Healthy cash flow isn’t just about how much is coming in and out of the business, but also about when it is coming in and out. For example, if too much goes out at one time and incoming payments are delayed, operations can come to a stop. While occasional cash shortages are okay, if cash is consistently tight and affecting the company’s ability to pay salaries, buy stock or service debts then there is a problem.

Slowing trade or an increase in stock levels

If incoming orders are slowing down and stock is building up, then there is a problem. Whether a competitor is undercutting, the market has moved on, or customers no longer want what you have to sell them, you need to find out what is happening and decide on how to respond

Poor relationship with lenders

A company’s solvency isn’t limited to its immediately available cash resources. It’s also dependent on what money can be raised by way of debt or equity injections. If current lenders are unwilling to issue further funding, alternative lenders are quoting excessive interest rates or the request to rollover a facility is rejected then there is trouble. These are signs that your bank or other lenders are dubious about the company’s viability.

Employees jumping ship

Employee turnover often precedes weak financial results. Particularly in the case of senior employees who may be privy to certain company details, if staff are jumping ship to competitors, they may be doing so out of concern for the business’s viability. And whether their fears were well founded or not, senior staff resignations can still affect performance and confidence. Essentially, if staff are leaving, you need to find out why and whether there are rumours circulating about the company’s health. The last thing you want is a mass exodus to create or exacerbate a problem

Lenders use Early Warning systems as well!

TMA Board member and credit veteran Peter Stevens commented;

“Lenders also use sophisticated monitoring systems to pick up potential problems early as experience has shown that if a problem is identified early enough it has a higher chance of avoiding a loss. Don’t be the company that first learns they have a problem from their lender. Be able to demonstrate that whatever the problem is, it has been identified and plans are in hand to address it. Lenders don’t like surprises so manage the dialogue and keep control of the situation. Remember, a business cannot function without cash, and if the whole issue looks daunting, TMA members can help.”

Turnaround professionals can assist

While there are many more signs that indicate a company is in or entering financial distress, these are some useful early warning signs to watch out for.

And if you can identify with some of these warning signs, you might consider contacting a turnaround professional.

TMA UK is part of TMA, a global organisation that represents the interests of turnaround professionals as its members who have the skills needed to assist companies in challenging times. If you need assistance, please contact our helpline on 0844 804 0116


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