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8 warning signs of financial distress

We have all heard the saying, ‘cash is king’, but when it comes to running a business, ensuring you have sufficient cash to pay staff, GST obligations, debtors and other operational expenses is crucial to maintaining the ongoing viability of your business.

Despite the importance of preserving strong cash flow, many business owners fail to monitor their cash position, often ignoring the warning signs, which if left unchecked, could sound the death knell of their business.

National Credit Insurance (Brokers) recently reported an alarming rise in the number of incoming claims against bad debtors; 143 claims were recorded in July 2009 as compared to 90 claims during the corresponding month in 2008. Hardest hit was the labour hire industry (recording $2.4 million worth of defaulted debts) followed by paper/printing ($1.5million) and building ($1.1milion).

The sharp increase in bad debt claims suggests that many businesses were unprepared for the slowdown in the economy, and were caught unawares by the strain placed on cash flow by defaulting debtors.

No luxury of hindsight

Even profitable businesses can fail simply by not having enough cash to fund operational expenses. Whilst most businesses will experience financial distress at some point, early diagnosis of problem areas can allow for corrective action to be taken, brightening future prospects. Careful financial monitoring puts a business owner in a position to recognise and confront the symptoms of cash flow trauma while intervention is still an option.

What to look for

Many businesses often show symptoms of having impaired cash flow but fail to recognise the warning signs until it is too late. There are eight warning signs all business owners must look out for which will provide crucial insight into the financial viability of a business. Of these, a lack of up-to-date financial information (especially reports related to taxation) should always set alarm bells ringing, as it indicates limited control and vision of where the business is headed.

Warning signs include:

• Continued erosion of margins, suggesting an inability to maintain market share and, ultimately, remain solvent;
• Expansion beyond a business’s financial means, so that the cost of resultant over-borrowing becomes a drain on the overall operation;
• Over-reliance on borrowed funds, resulting in a significant proportion of gross profits being directed at servicing the loan;
• Inadequate capital base, creating problems in financing ongoing operations and growth;
• Lack of cash flow forecasting, in particular the absence of a cash budget;
• Difficulty paying creditors and/or meeting GST and PAYG obligations (a common mistake is to use tax as a ‘float’ to keep cash flow positive); and
• Continual capital/loans injection, for if a business is not structured for recovery then any over-capitalisation will be impossible to service from internal generation of funds.

If a business discovers that they are in fact heading towards cash flow trauma, the first step should be a thorough review of outstanding debts. Business owners need to be diligent in their approach to managing their accounts receivables. Clearly communicating payment terms to customers, invoicing on delivery and promptly following up outstanding debtors are just some ways to can keep on top of payments owed.

Debtor finance is also an attractive cash flow solution for businesses as it allows businesses to turn their accounts receivables into much-needed cash in the bank.

This article was first published in Dynamic Business.