Signs of Financial Distress

What is financial distress?

Financial business distress refers to a situation where a company is experiencing financial difficulties and is at risk of defaulting on its debts or going bankrupt. This can be caused by a number of factors, such as declining sales, increased competition, or high levels of debt.

1. Consequences to Business Owners: Financial business distress can have serious consequences for both the company and its stakeholders, including shareholders, employees, and suppliers. If the company is unable to turn its financial situation around, it may have to liquidate its assets, lay off employees, or even go bankrupt.
   
   

2. Problems with investment: Businesses in financial distress may also have difficulty attracting investment, which can further exacerbate their problems. 

Financial distress can ultimately lead to bankruptcy or other forms of restructuring, if not addressed and resolved in a time.

Where to spot signs of financial distress

Looking at the company’s accounts will give a good indication of how it is performing. 

high debt-to-equity ratio

1. Cash flow: The first sign things are going wrong is always being short of cash. All businesses suffer periodic dips where cash is tight. If cash flow problems become more regular, the business is usually in trouble. If a business is continually spending more than it earns, unless it is deliberate and well funded (by investors) it will lead to problems.

2. High interest payments: This could indicate poor creditworthiness and be a sign your bank or other lender is cautious of your viability. If lenders view you as high risk, borrowing will cost more. It's also a bad sign if lenders always seek personal guarantees or security against any money they lend.

3. Defaulting on bills: Occasionally, your business might miss a payment or forget a bill, but if this becomes a regular occurrence, it suggests a business is struggling financially. HMRC payment defaults can be particularly damaging. It can also damage your reputation and that of your business.

4. Extended payment days: If your business has to delay payments to creditors, this can force some suppliers to place a freeze on your trade accounts. Sudden changes like these should be investigated to see whether they are signs of something more serious.

5. Falling margins: If profits are declining and not sales. margins will fall and suggest that costs are too high and prices or income is too low. This is not a sustainable position.

6. Unhappiness: Businesses in financial distress are rarely happy. Owners and managers can get noticeably stressed. Lots of senior people may leave in a short time if they identify that the company is under financial pressure.

Typical signs of financial distress

Signs of financial distress in a business can include:

• Decreased revenue (income) or increased operating costs (expenses)

• Delayed payment of debts or suppliers

• Not paying statutory payment e.g. Tax, VAT, National Insurance, pension contributions

• High debt levels or increasing debt obligations

• Decreased profit margins

• Poor cash flow management

• Over-reliance on short-term financing

• Increased difficulty obtaining financing

• Decreased investment in development

• Layoffs or reduction in workforce

• Assets being sold off or liquidated

• Business owners/director stress

• Personal debts due to low director income

It's important to keep in mind that these are general indicators, and financial distress can manifest differently for each business and industry.

Insolvent distress

Cash Flow insolvent: Cash flow insolvent is where a company cannot pay the debts it owes when they are due.

Balance sheet insolvent: Balance sheet insolvent is where the company’s debts are greater than the value of the assets it owns.

Once a company reaches this stage, the available options are limited, and many companies in this situation will end up in a formal insolvency procedure. However, this is not always the case, and the earlier you seek professional advice, the more options there are to resolve the company’s financial distress.