Corporate recovery: recognising red flags early

Difficult Trading Conditions

There is a general acceptance that trading conditions are becoming more difficult across all business sectors.

It’s fair to say that it is not difficult for entrepreneurs to know when a company is in financial distress but all too often this is identified far too late and a business has deteriorated to the point of being insolvent.

One of the biggest difficulties for entrepreneurs when operating in challenging economic conditions is finding the time to “work on the business” rather than “work in it” and to recognise potential red flags before they become crises for the business. In this regard, time taken to find, accept and act on the red flags can mean the difference between a business surviving the troughs and enjoying future peaks or not.

Our experience shows that in business that the following

are the most common red flags or early warning signals and as such, business owners need to be aware of them and constantly check them.

These warning signals and flags can be broken down into financial and non-financial symptoms of financial distress.

Financial Red Flags

• Decreasing profitability.

• Decreasing sales volume at constant prices.

• Increased gearing.

• Management time increasingly spent on cash flow management and short-term crisis.

• Worsening working capital position including carrying an increase in average stock levels/experiencing a slowdown in stock turnover.

• Increase in debt.

• Experiencing short or medium-term cash flow issues including operating on a hard-core overdraft.

• Availability of credit and funding increasingly restricted.

• Poor accounting practices including the late filing of accounts in the Companies Registration Office.

• Late payment from customers.

• Requiring increased payment terms from suppliers.

• Creditors threatening to commence legal proceedings against your business.

• Demands from Revenue being followed up with tax arrears notices and visits from the Sheriff.

• Difficulties with credit insurers.

Non-Financial Red Flags

• Loss of customers.

• Management indecision.

• Management turnover.

• Lack of planning/strategic thinking.

• Lack of attention to detail.

• Factional management.

• Lack of communication with stakeholders.

• Owners taking non-commercial salaries to support the business.

• Your product/service is a discretionary spend.

This year’s survey highlighted the following:

► 37% of respondents products or services are discretionary spends which may be cut.

► 35% of respondents are experiencing short- or mediumterm cash flow issues.

► 33% of respondents are experiencing late payments from customers.

► 30% of respondents are firefighting in the business daily rather than proactively managing the business.

► 22% of respondents are experiencing slowing trade or trade not returning to pre-pandemic levels.

These trends show that businesses are under increasing pressure.

Cash flow

The biggest red flag of all is cash flow. It is often said in business turnaround, that there are two types of companies that fail – those that makes losses and run out of cash or those that make profits and run out of cash.

Turnaround Suitability

Any sign of cash flow difficulties should be taken seriously. Gaining advice from your local financial adviser can assist the severity of the company’s situation and answer the key question as to whether the company can be made viable.

There is a dividing line between when a company is suitable for a turnaround or whether it should be placed into a formal insolvency procedure. If turnaround is not an option because a company’s problems are too severe, restructuring can still enable the company and/or its business to survive. The term ‘restructuring’ refers to a range of formal insolvency processes aimed at helping businesses in significant distress – including SCARP and Examinership.

However, no viable company should need to experience these processes. Timely consideration will enable you to identify what is wrong and then formulate a preliminary action plan which outlines how to fix the issues and the key strategies required to turn the entity in the right direction. In this regard, companies that act early, are better able to formulate a greater number of possible options and sustain their success for a longer period.

SCARP

What it is: The Small Company Administrative Rescue Process (SCARP) is a legal procedure that provides a simplified and cost-effective way for small companies in financial distress to restructure and potentially rescue their business. It is designed to help companies avoid liquidation and closure by providing a mechanism to negotiate with creditors and implement a rescue plan.

SCARP allows eligible small companies to propose a rescue plan to their creditors. If the plan is approved by the majority of creditors, the company can move forward with the restructuring. This process aims to provide a more streamlined alternative to traditional insolvency procedures, helping small businesses overcome financial difficulties and continue operating.

Examinership

What it is: Examinership is a legal process that provides a company in financial distress with an opportunity to restructure and potentially avoid insolvency or liquidation. It is designed to give struggling companies a chance to survive by providing a protected period during which they can negotiate with creditors and develop a plan to reorganise their finances and operations.

During the examinership process, a qualified insolvency practitioner called an “examiner” is appointed by the court. The examiner’s role is to assess the company’s financial situation, work with management to develop a viable survival plan and propose this plan to creditors for approval. The protection granted by the court prevents creditors from taking legal action against the company during the examinership period. If the proposed survival plan is accepted by the required majority of creditors and approved by the court, the company can proceed with its restructuring efforts. If the plan is not approved, the company might face liquidation. Examinership is a significant tool for companies in financial distress to try and regain stability while protecting the interests of various stakeholders.