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Top Five Signs That a Company is in Financial Distress

by | Aug 23, 2022 | Finance | 0 comments

With rising inflation and ever-increasing economic volatility, it’s important for anyone who has significant business dealings with companies to make sure that the companies they do business with are in a position to fulfil their obligations. It’s especially important for B2B companies to ensure that clients and borrowers have the capacity to pay back for any money borrowed or goods received. At the end of the day, if one of those companies is dissolved, your business may experience severe losses with no guarantee of recuperation.

Being able to track the performance and financial information of companies you do business with is vital in ensuring that you do not take on any unnecessary financial risk. Oftentimes, poor due diligence can lead to future disaster and there has never been a more crucial time to avoid financial worry. Services such as DataGardener’s Expand Plan and Company Search feature are designed to make this process as easy as possible, with custom alerts for any company you need to keep your eye on. With that said, here are some of the top 5 signs that a company is in financial distress, and how our services can help you identify and mitigate these risks.

1. Cash Flow Issues

Cash flow issues are perhaps the most important sign that something is amiss with a company’s financials. This isn’t to say that every company that is tight on cash is due for subsequent failure, every market is different and standards for cash flow can vary across the board. It’s also important to note that cash flow varies like the seasons – sometimes it can get a little tight in certain periods, but so long as it bounces back there should be no issue. However, if a company has persistent and significantly less cash flow than the average for a certain sector, it’s likely that the business is in trouble.

Poor cash flow also hints at a few other potential underlying problems. For example, if a company cannot afford to pay your business, it’s also likely they can’t afford to pay other suppliers, their own employees or even HMRC – signalling potential future legal trouble.

Sometimes, a business will deliberately spend more than it earns per month. This is the case in businesses such as new tech companies with a heavy focus on research and development (R&D). This is perfectly natural and as long as the investors have faith in the end product, it isn’t a problem. In other companies, poor cash flow could be down to several factors such as excessive overhead costs, high-interest loan repayments or generally poor spending decisions. Regardless, companies with a poor cash flow are to be avoided if your business cannot handle extra risk.

2. Slow Bill Payments

Alongside cash flow, extending debtor or creditor days is a second sign that something is off with a company’s financial health. Delaying payments to creditors for example may force some suppliers of that company to cut off vital services or goods being provided. In general, payment behaviour is a large sign of overall decline, especially if that company was previously very good at making payments on time. Attempting to re-negotiate payment terms is also indicative of distress, and this can also turn into false invoice disputes in order to gain more time to pay the bills.

Alongside slow bill payments also often comes a breakdown in business communication. Understandably, if a client is refusing to pay bills in the agreed payment terms, you may well attempt to contact the business to find out what is going on. Leaving calls and emails unanswered is a common symptom of this, and you may also find it difficult to access the people in positions of authority to question them about the lateness of bills.

From the outside, it can be difficult to tell whether a company will be slow at paying bills before you go into business with them. However, business data services such as ours can identify which companies other companies are closely related to and doing business with, as well as which shareholders are the most closely linked. Being able to ask other companies already doing business with a prospective client about bill payment times can give you an idea of whether you would want to go into business with them also.

3. Falling Margins and Other Profit Modifiers

Any business professional will be able to tell you that, at the end of the day, profits are what ultimately determine whether a business is successful or not. Falling margins of a business providing goods or services means that, somewhere along the line, costs are too high and prices are too low. This eventually causes cash-flow issues and, if the trend carries on, insolvency.

Falling margins aren’t the only product-centric sign that a company is slowly failing. Markers such as raw sales can also be a significant factor. If a company simply isn’t selling enough products to make ends meet, then it doesn’t matter how good the margins for their products are. However, in cases such as these, it may also be wise to determine exactly why sales have decreased. For example, coffee chains such as Starbucks may have taken a huge hit throughout the pandemic due to the reduced footfall in city centres and shopping districts, but this certainly doesn’t mean that the business is failing since the problem is clear, universal, and temporary.

A more worrying reason for a reduction in sales may be that customers simply aren’t coming back to the company for repeat purchases. This could be for any number of reasons, but the bottom line is that there is something faulty in either the purchased product, the quality of the said product or customer interaction. Whatever the reason, a lack of repeat customers is not indicative of a company which is financially healthy – but of course, this also depends on the sector.

4. Decreased Morale and Management Issues

Although it may sound simplistic to say, general unhappiness remains one of the greatest signs that a company is in financial distress. If a company is thriving, treating its employees well and providing returns to shareholders, morale shouldn’t be an issue. However, a high employee turnover and decreased morale may be one of the first signs of a company going the opposite direction. Although COVID loans have mitigated much of the feared layoffs in UK businesses, long-term difficulties in maintaining skilled staff and a productive workforce remains indicative of a troubled business.

This also extends to owners and senior managers of businesses. Owners and managers of businesses under financial distress are often more prone to make rash decisions which can derail the company even further. This also presents as lots of senior people leaving a company at the same time, since it’s hard to keep the financial shortcomings of a company secret for any length of time. It may also be a good idea to monitor the dividends being paid to directors and shareholders of the company since these can also give a good indication that something is wrong. In fact, dividends are usually the first items to be cut back on or removed altogether when a company first enters serious financial distress.

5. Unexpected Sales of Stock and Assets

When senior members of companies forecast that the business is likely to enter a period of financial distress, their first course of action may be to sell some of their own shares to avoid personal financial trouble. Although this is not as common of an indicator as some other items on this list, it can certainly give you some warning as to when a director or shareholder is expecting a company they have significant investments in to start experiencing difficulties. However, it can be risky to infer too much about a company’s financial situation just by the financial activities of its shareholders and overall stock price since these could also be natural financial movements and not indicative of any troubles within the business.

A company selling off unwanted or underperforming arms of their business is also not necessarily indicative of financial woes, but it depends on how much and what is being sold. When a business starts to sell off integral assets, this is a much more sure-fire sign that the company is in financial difficulty. This could take the form of selling rights to flagship products, IP rights and other means of raising short-term funds. This could also be the selling of real-estate that the company owns or downsizing its offices. Judging the unexpected sale of stocks and assets and its impact on business financial health is more of a case-by-case basis than a definitive indicator.

How Can DataGardener Help Your Business?

Here at DataGardener, we have multiple tools available to help our clients conduct heightened due diligence on potential business opportunities. In particular, our Expand Plan provides businesses with tools to take their financial risk management a step further through comprehensive due diligence. Our database of UK companies allows businesses to easily access integrated data from multiple sources – saving you both time and money.

Through our services, your business can learn how to use data-driven intelligence to protect your company from risk by understanding the financial performance of your prospects and customers. Additionally, our services include information and insights into company shareholders and whether the business is being managed efficiently and responsibly before you enter into business with them. We also provide instruction on how to use our platform to view Charges, CCJs and Advanced Company Credit Reports to determine if a company has a good payment record.

To sign up for a demo of our award-winning platform, please click here and fill out the enquiry form at the bottom of the page or you can directly signup here.


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