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Yorkshire chair of R3, gives some tips for spotting business distress

Months after the initial lockdown, it has become clear that the pandemic will create long-term or even lasting changes that will mean some businesses are no longer viable.

Yorkshire chair of R3, gives some tips for spotting business distress

"In the midst of the pandemic, businesses need to be more vigilant than ever. Reviews of financials and comparisons with forecasts will reveal any adverse trends and allow you to take action early "
Eleanor Temple, Yorkshire Chair of R

As the Government gradually withdraws the support packages available, it is vital that managers assess their business in light of the new normal.


The sooner you spot the warning signs and take action, the more options you will have to save the business. Insolvency and restructuring professionals are there to help struggling companies achieve the best possible outcome. The UK insolvency framework offers a whole range of tools they can draw upon, including some new measures which could benefit many more businesses.


Insolvency - seven warning signs to look out for

In the midst of the pandemic, businesses need to be more vigilant than ever. Regular reviews of financials and comparisons with forecasts will reveal any adverse trends and allow you to take action at an early stage. Here are seven key signs to look out for:

1. Cashflow problems - this is usually the first noticeable indicator. If you are constantly hitting your overdraft limit, it is a cause for concern. Investigate the underlying reasons. Don’t just look at turnover, focus on net profit and how this can be increased.


2. A drop in sales -  or maybe they are lower than expected. Are you losing out to the competition, or has demand fallen and, if so, why? And could it be a longer-term market trend?


3. Increased costs – unexpected expenses, projects running over schedule, the need for additional staff can all tip the balance, especially where margins are tight.


4. Issues with suppliers – even where demand has held up, many businesses have suffered supply chain problems during the pandemic, and the Brexit situation could create further complications.


5. Insolvency of a customer – in 2018, R3 found that one in four UK companies had been hit by the ‘domino effect’ of another company’s insolvency in the last six months. Don’t get caught out by a sudden bad debt: as with your suppliers, maintain regular contact, regularly check credit ratings for your customers, and monitor any changes in terms of trade or more subtle signs such as redundancies or departure of key personnel.


6. Inability to meet tax bills or other repayments  – missed payment deadlines can lead to a spiral of interest and penalty charges. While HMRC is allowing companies to defer payments, and lenders may be more understanding at this time, it is only a short-term solution. If your business can’t meet its obligations, it is technically insolvent.


7. Seeking new funding – going to the bank to borrow more money or having to rely on alternative types of funding that you wouldn’t normally consider can also be signs of trouble. It is also likely that you will be required to give personal security such as a charge on your home.


How to tell if you are insolvent

There are two principal measures of insolvency - the balance sheet test, where all liabilities exceed assets, or the cashflow test, where the business cannot meet its liabilities as they fall due. If a business fails either of these tests then it is deemed insolvent.


If the business is clearly in trouble but not yet insolvent, act quickly and get help from your accountant or an insolvency practitioner. Early intervention allows a much wider range of options – for example, you can sell off or close loss-making parts of the business, find ways to reduce costs, agree revised terms with creditors, find new sources of funding, or use an informal restructuring procedure. Or, if you feel the business has no future, you can choose to close it down.


Once a business becomes insolvent, directors have an obligation to protect the interests of creditors and employees and ensure that the position does not deteriorate further.


However, even insolvency is not necessarily the end of the road – many businesses are able to be rescued via an insolvency procedure, giving entrepreneurs a second chance.



Insolvency - the options

Moratorium- this new option for businesses was fast-tracked by the Government as part of the response to the pandemic. It gives an initial 20 day protection from creditor action which can be extended if required. This allows viable and eligible companies breathing space to consider either a restructuring package or a CVA (see below) as a rescue process, or to look at other ways of rescuing the company as a going concern.


Restructuring Plan – this new tool introduced recently by the Government in response to the pandemic allows companies to agree a compromise with creditors to restructure their debt with the oversight of a court. While it is not strictly an insolvency procedure, it is legally binding and similar to the existing ‘Scheme of Arrangement’.


Company Voluntary Arrangement (CVA) – Although sometimes associated with big retailers trying to renegotiate rents, CVAs can be used by any company provided the underlying business is potentially profitable. The company agrees with creditors to restructure its debts, usually by making contributions from future profits, or in part from the sale of assets. The role of the insolvency practitioner is to supervise the arrangement and distribute funds to creditors, while the existing management team usually stay in place to carry on trading.


One issue with CVAs in the past has been that the company is at risk of creditor action while agreeing the CVA. However, the new moratorium as outlined above could be used to give a company time to come up with a strong CVA proposal, which could enhance its chances of being voted through by creditors.


Administration – suitable for companies which are unable to meet their liabilities but where the underlying business is potentially viable. Administration provides protection against creditor action so allows time to rescue the company as a going concern, or to find a buyer for the business. The administrator – who must be a licensed insolvency practitioner – manages the company's affairs during this period.


Pre-pack administration – this is where a sale of the business and/or its assets is arranged in advance and completed just after it goes into administration. To use a pre-pack, the administrator must show in their report that it is the best option in the circumstances, and is required to undertake a marketing exercise of the business and/or its assets in order to get the best possible price on creditors’ behalf. In some pre-packs, the business is sold to a connected party (such as an existing director or owner), but again the administrator must show that it is the best way to maximise returns – often the previous management team will be the ones with the necessary knowledge to make a go of the new company.


Liquidation - where there is no prospect of a rescue, the company is closed down, the assets sold and any money raised is returned to creditors. A Creditors’ Voluntary Liquidation is where the directors themselves are proactive and call in an insolvency practitioner to wind up the business and, as with all early action, is preferable to the alternative, where creditors take enforcement action resulting in a Compulsory Liquidation. In this case, the Court and the Government’s Official Receiver become involved, the business incurs additional fees, and there may be more serious potential consequences for directors.


Which option is right for my business?

Choosing the best insolvency or restructuring option for a company is a serious decision, not to be undertaken lightly. A licensed insolvency professional will provide bespoke advice about which of the processes are available and appropriate for your business. Some will give their initial consultation free of charge. Early intervention by a qualified and regulated insolvency professional could be the difference between ‘make or break’.


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