Corporate insolvency: taking action to avoid it

With bank interest rates continuing to rise and with the highest level of corporate failures since the second quarter of 2009, what action can companies take to alleviate the pain?

The statistics on corporate insolvencies for the second quarter of this year paint a relatively grim picture, after the Insolvency Service reported that 6,342 companies in England and Wales were registered as insolvent.

This represents the highest level of corporate failures since the second quarter of 2009, when insolvencies were rife following the great financial crash in 2008.

Small businesses entering liquidation processes account for 83% of these insolvencies, as the macro-economic conditions, low consumer confidence and the pressure of repaying COVID loans continues to take effect.

Worrying still, is that a number of businesses, like homeowners, have yet to refinance their debt, meaning the full impact of higher interest rates may yet to be felt.

Inflationary pressures show no sign of abetting, so businesses operating with slim profit margins which once enjoyed the advantages of inexpensive loans are now confronting substantial challenges.  

Consequently, careful financial resilience planning, particularly in times of distress, will help with decision making during these difficult times, which we examine in further detail below.

1.    Cash-flow assessment

It is obvious to say that cashflow is critical, but far too often businesses do not properly understand or closely monitor their cashflow situation.

Short-term cashflows should be prepared to map out when customers are expected to pay and when costs have to be met.

From this, pinch points will become clearer, which will enable earlier, informed decisions to be made.

For instance, you may need to approach a key supplier about delaying payment, or you may need to discuss a payment plan with HMRC.

By not planning for those cashflow difficulties, the likelihood of debt collection action will increase; you might be put on stop, your credit position will be impacted, and of course the risk of insolvency proceedings being instigated against the business will increase.

2.    Business plan

Short term cashflow is critical, but determining the underlying problems and long-term viability requires a much broader assessment of the business, which should involve preparing an integrated projected profit and loss account, balance sheet and cashflow position.

This will then enable management to make more strategic decisions about the business.

For instance, should we explore new markets? Should we exit a particular customer or close a loss-making part of the business? Can we reduce the fixed cost base? 

3.    Distressed funding

With borrowing costs continuing to rise, choosing the right lender and the right type of funding to suit the needs of the business has become more important.

Our specialist funding advisory team can help you assess your options and implement the necessary changes, on which further information can be found in our Funding Advisory Knowledge Hub.

4.    Creditor negotiation

Once future cashflows have become clearer, properly structured, affordable repayment proposals can be formulated for discussion with key creditors. HM Revenue and Customs, for example, who is often one of the principal creditors in businesses, is typically willing to consider payment terms, but there will need to be substance behind them, often supported by the opinion of an independent professional.

If payment terms are stretched, short-term cashflows will improve. 

5.    Remuneration policy

It is not uncommon for directors to lend to their businesses, which can be a flexible and cost-effective way of improving cash flow, but independent advice on the merits of doing so should be considered beforehand.

All too often we see directors inject significant funds into a failing business, only for the business to then collapse into an insolvency procedure. The lack of plans often means that the decision to lend is then one of regret – “don’t throw good money after bad”, as they say.

The solvency of a business and its future prospects should be independently assessed before those decisions are made. 

In times of distress, we would also recommend that a regular review of the remuneration policy is undertaken, particularly when the director/shareholders are remunerated by way of dividends, mainly, rather than by salary.  This is because dividends are considered unlawful in a situation where there are insufficient reserves, leaving an overdrawn loan account position for the directors to address in an insolvency procedure. 

6.    Customers

As part of your financial review, look at your customers individually and assess profit margins, and consider exiting those which are not generating a contribution for the business.

Similarly, review your credit terms – can terms be improved, balancing that off against maintaining customer relations, and could you perhaps introduce early discounts to alleviate short-term cashflow pressures?

7.    Director’s Responsibilities and Obligations

The above points focus on the business itself,  but of equal importance are the director’s responsibilities and obligations. 

In the eyes of the law, a company is considered technically insolvent when it is unable to meet its debts as and when they fall due, or if the value of its assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.

When a company is insolvent, the director’s fiduciary duties switch to the creditors, to whom they owe a duty to minimise their losses. During this “twilight” period, the director’s actions are subject to a great deal of scrutiny if the business subsequently enters certain insolvency procedures.

And in a situation where a director has acted improperly, there are ramifications in the form of disqualification, financial claims and criminal proceedings, potentially.

What does all of this mean, in reality?

Firstly, regular reviews of the company’s solvency must be undertaken – reviewing the financials at the year-end is simply not enough.

Where solvency is unclear, or if an insolvent position presents, independent advice should be sought. This will help to ensure that all options can be properly explored in the interest of relieving the pressure and safe-guarding the business, and it will provide clarity to directors on the actions they should and should not take to protect themselves personally.

Some of the common pitfalls in this respect include:

• Declaring unlawful dividends which then become repayable, hence the need to consider the remuneration policy as noted above
• Disposing of assets for less than their fair value
• Disposing of/transferring the company’s business for less than its fair value
• Preferring certain creditors over others
• Insolvent trading
• Trading to the detriment of the Crown

This is not an exhaustive list.

8.    Formal Insolvency Proceedings

If the financial position is such that the company is unable to trade its way out of its difficulties, and insolvency proceedings are considered necessary, this provides the company with a mechanism for properly dealing with its creditors and winding down its affairs in a structured and legal fashion.

Further, in a situation where the company is insolvent but is otherwise considered viable, formal insolvency procedures such as a Company Voluntary Arrangement and Administration can help to rescue the business.

Liquidation, on the other hand, is often the route taken for an insolvent, terminal company.

Contact us

Restructuring involves foreseeing challenges and implementing solutions before problems becomes insurmountable. Please let us know if we can be of assistance. 

Check out our Top 3 Myth-Busting Facts on Refinancing for Businesses.

If you would like to discuss finance for your business, please get in touch with a member of our Funding Advisory team for an informal conversation.