Businesses can experience financial difficulties for various reasons, but recognising the early warning signs of financial stress and potential insolvency can help prevent a full-blown crisis. Identifying these indicators early allows business owners, accountants, and financial advisors to take corrective action, potentially saving the business from collapse.
In his session, An Introduction to Insolvency 2025, Shaun Hudson gave insight into some key warning signs that a company may be heading towards insolvency.
1. Declining Sales and Revenue
One of the most obvious signs of financial distress is a consistent decrease in sales or revenue. A drop in the number of orders over time indicates that demand for the company's products or services is waning. This decline can result from market shifts, increased competition, or internal inefficiencies. If revenue continues to fall without a corresponding reduction in expenses, the business's profitability and cash flow will suffer.
2. Increasing Costs
Rising costs can place significant strain on a company's financial health. These costs may include:
- Higher wages due to changes in minimum wage laws
- Increased utility bills and supplier prices
- Elevated borrowing costs due to interest rate hikes
- When expenses rise faster than revenue, profit margins shrink, and the business may struggle to meet its financial obligations.
3. Breach of Bank Covenants
Businesses often have agreements with banks that include financial covenants, such as maintaining a certain level of profitability or liquidity. A breach of these covenants can lead to serious consequences, including reduced credit limits or immediate repayment demands. Banks may take further action, such as calling in loans or pushing the company into insolvency proceedings. Early engagement with the bank to negotiate solutions is crucial in such situations.
4. Delayed Financial Reporting
When a company starts delaying the preparation and submission of financial reports, it may indicate underlying financial problems. Business owners sometimes avoid providing financial information because they fear facing the reality of their situation. However, timely financial reporting is critical for decision-making and planning. Avoiding financial disclosures can lead to missed opportunities for intervention and recovery.
5. Creditor Pressure and Late Payments
Struggling businesses often find it difficult to pay suppliers on time, leading to increased creditor pressure. Suppliers may impose stricter credit terms or stop supplying goods altogether. An increasing reliance on extended payment terms and overdue bills can signal worsening financial health.
6. Increasing Tax Liabilities and HMRC Pressure
Many companies use tax payments as a temporary cash flow management tool by delaying payments to HM Revenue & Customs (HMRC). However, this can be a risky strategy, as HMRC has intensified its debt recovery efforts, including issuing winding-up petitions against companies with outstanding tax liabilities. A pattern of growing tax debts and missed deadlines can be a strong indicator of financial distress.
7. Owner Distraction and Leadership Issues
When business owners or directors are consumed with addressing financial problems, they may neglect strategic planning and business growth. Constant firefighting can take a toll on leadership effectiveness and decision-making. If key decision-makers are overwhelmed by financial stress, it can lead to poor choices and further deterioration of the business’s financial position.
8. Increased Borrowing and Risky Loan Decisions
In desperate attempts to resolve financial difficulties, business owners may seek short-term loans, often with personal guarantees. While this may provide temporary relief, it can create significant personal financial risk and long-term debt burdens. Seeking professional financial advice before taking on additional loans is essential to avoid worsening the situation.
9. Directors’ Loan Accounts and Unplanned Withdrawals
Many business owners rely on director’s loan accounts to withdraw funds from the company in anticipation of future profits. However, if a company is already struggling, these withdrawals may not be backed by sufficient retained earnings. In the event of insolvency, these loans may need to be repaid, increasing personal liability for directors. Shifting to a structured salary approach can help mitigate this risk.
The Importance of Seeking Early Advice
One of the biggest mistakes struggling businesses make is waiting too long before seeking professional advice. By the time directors acknowledge the severity of their financial issues, the available options for recovery may be significantly limited. Consulting insolvency practitioners, financial advisors, or accountants at the first sign of trouble can help explore alternative solutions, such as restructuring or negotiated settlements, before insolvency becomes inevitable.
Recognising early warning signs of financial distress can be the difference between business survival and insolvency. By actively monitoring financial performance, maintaining open communication with creditors and banks, and seeking professional guidance, businesses can take proactive steps to mitigate risks and improve their financial health. Acting early increases the chances of recovery, protecting both the company and its stakeholders from the harsh consequences of insolvency.
To watch the full session, please click here. In this course Shaun Hudson covers the following topics:
- Early warning signs of financial stress or distress
- Benefits of early advice
- Director’s common law and statutory duties
- Common insolvency processes and procedures
- Consequences to directors for breaching duties
The contents of this article are meant as a guide only and are not a substitute for professional advice. The author/s accept no responsibility for any action taken, or refrained from, as a result of the material contained in this document. Specific advice should be obtained before acting or refraining from acting, in connection with the matters dealt with in this article. The information at the time of publishing was accurate and could be subject to final changes.
