Storm Warnings

It is an unfortunate fact that many businesses fail because their owners or directors have either not spotted the warning signs in time, or delayed taking action because they think that things will shortly turn around by themselves.  This happens to otherwise very effective owner managers because there is usually a delay between the boat springing a leak and that sinking feeling. If you take action at the former rather than the latter stage you will have a much greater chance of turning things around.

If you have access to a qualified accountant either in house or externally you can ask them to calculate your Z-score as part of the management accounts process, or on a regular basis.

The Z-Score is the most thoroughly tested and broadly accepted distress prediction model. It applies statistical techniques to financial ratios to determine the overall health status of a business:

  • Healthy Zone: the business is in good shape.
  • Danger Zone (zone of ignorance, zone of uncertainty): warning signals, lenders and trade suppliers need to exercise caution, and owner managers need to take action.
  • Failing Zone: high likelihood of bankruptcy within one year.

Ensure your accountant uses the correct model – the private company model is different to the quoted company model and there are different ones for manufacturing and non-manufacturing businesses.

If you don’t have access to this expertise, early warning signs you need to watch out for include:

  • Adverse financial signals such as declining gross margins, declining market share, worsening working capital, rapidly increasing debt, and a general atmosphere of cash being tight
  • Adverse behavioural signals such as poor communication, low morale, bad housekeeping , high management turnover

By the time that clear day to day symptoms appear - such as severe creditor pressure, being unable to get new credit, delaying your VAT returns - you have probably already entered firefighting mode whether you realise it or not, and your room for manoeuvre is more limited. The most common reaction to these symptoms – and this is human nature – is to assume all will be put right by that new contract or that large debtor receipt due any day now. This is rarely the case in reality and if you can resist thinking like that, the good news is that you still have options even now, but you are likely to need professional help in saving the business.

It’s always best to take action when everything is in your own hands and assuming you have already done the obvious such as cutting unnecessary costs, you can avert problems by a combination of actions focussed on sales, cashflow and profit. There are a myriad of examples but a few might be:

  • Benchmark yourself against others in your industry to identify areas where you can improve – industry statistics such as gross margin should be publicly available through trade assocations etc, or your accountant may have software that gives you a benchmarking report
  • Understand and manage your breakeven point so that you are more able to survive falls in demand
  • Improve your debtor collection days and reduce hassle by moving customers onto direct debit. This is now being used in many more industry sectors than was previously the case. You could incentivise your customers with a discount for doing so provided the benefit of accelerated cashflow outweighs the drop in margin.

As any doctor will tell you, as a general rule the earlier a patient is diagnosed the better the outcome.