money management

Proactive Measures for Businesses to Prevent Insolvency

June 9, 2023 By Eddie Senatore

Dealing with a company which is or likely to be becoming insolvent can be a time of great anxiety and stress for a business owner, but even if you’re hitting some tough times when it comes to paying your bills, it’s not inevitable that it will all end badly.

Here are some ideas for proactive ways you can turn things around and prevent insolvency.

Strategies for Cash Management

If you maintain good control over your cash position, you’ll have a much lower chance of running into trouble paying your bills. Take a strategic approach to cash management with these three cash flow management activities.

Monitor cash flow regularly

Create a cash flow forecast and keep it regularly updated so you can quickly identify any pinch points where you could be struggling to pay your bills. If you know in advance that you may have a period of difficult cash flow coming up, you can make plans to mitigate the issue before it becomes a big problem.

Optimise working capital

Your working capital is the money you have available to do business. Working capital is made up of your cash at the bank, accounts receivable (debtors) and stock less your current liabilities (creditors).

Optimising your working capital means you reduce your stocks and debtors as much as possible, and you negotiate longer payment terms with your suppliers. It all adds up to more cash in your bank account when you need it.

Consider alternative funding sources

When cash is tight, you may need to consider drawing on other methods of funding your business, even borrowing from family and friends. Longer-term options include mortgages and finding new investors to boost cash balances, but it’s wise to discuss options with your accountant and business advisors. Before taking on more debt or increasing the equity in the business, make sure you understand the potential consequences for future performance.

Strategies for Diversification

An alternative strategy to increase cash and mitigate insolvency risks is to diversify your business. You can do this in a few different ways:

Expand product and service offerings

The obvious way to diversify your business is to add new product ranges or service packages. You could enhance your offerings organically, or if you’re prepared and able to borrow more, you could choose to acquire existing products from another company.

Develop strategic partnerships

When cashflow issues hit your business, you might feel that the best thing to do is to tighten your belt and downsize to reduce costs. However, a smart strategy could be to leverage new and existing relationships with others working in a similar niche to you. Collaborating can help you to achieve more while sharing costs with one or more other companies to keep costs manageable.

Explore new business models

Why not consider developing new markets for your existing products or services? This might include expanding into new geographies or finding new clients in different industries.

Diversify revenue streams

Be careful not to rely too heavily on a small number of customers for a large portion of your revenue. This creates more insolvency risk if you suddenly lose a large contract or your customers reduce their order sizes, perhaps in times of recession or other economically challenging market conditions.

To avoid receiving an insolvency notice, you may need to think laterally and consider new business directions that you haven’t thought about previously.

Strategies for Risk Management

Managing risk is a massive part of being a successful business owner. Your business is at risk from all sorts of potential issues, including security, operational, legal, environmental and, of course, financial. However, you can implement the following risk management strategies to reduce your insolvency risk.

Identify and assess risks

Using your financial statements, identify and assess any insolvency risks in your business. Ask your accountant to help you interrogate your accounting records and review the following information:

Ratio Analysis

Companies can assess their insolvency risk by reviewing their current ratio, debt-to-equity ratio, quick ratio and interest coverage ratio.

The current ratio is current assets/current liabilities, and most industries aim for 1.5 to 2 for this ratio to show a healthy level of liquidity.

The debt-to-equity ratio is current liabilities/owners’ equity – aim for 1 to 1.5 or even 2 if in certain industries such as manufacturing.

The quick ratio is current assets less inventory/current liabilities and is one of the best tests of a company’s liquidity. The ratio should fall in the range of 1 to 10. A quick ratio higher than 10 suggests that your debtors are too high.

Finally, the interest coverage ratio is net profit/interest expenses and shows how many times you can cover your borrowing costs from your net profits. Often, investors like to see that this ratio is above 3.

Cash Flow Analysis

Your cash flow analysis is one of the most important financial statements to update on a regular basis. It enables you to track whether you have sufficient funds to meet upcoming bills. If you have negative cash flow or low cash reserves, you may be at greater risk of insolvency.

Credit Risk Analysis

Your company’s creditworthiness is another way to assess insolvency risk. Credit rating agencies determine your credit risk profile using information from your financial statements, current industry trends, the current economic situation and your credit history to evaluate your overall credit risk. If you have a high credit risk, you may find that borrowing costs are increased with higher interest and set-up fees as well as tighter criteria for accessing credit facilities.

Develop risk mitigation strategies

Aside from the diversification strategies mentioned above, there are other risk mitigation strategies that could be helpful in reducing your chances of going insolvent.

Financial Management

For an early heads up on potential insolvency risk, pay attention to your financial management processes. Regularly produce and review your P&L, balance sheet and cashflow forecasts to ensure you have oversight of any potential future issues. When you fully understand what your financial statements are telling you, you can plan for any cash flow squeezes in advance and avoid running out of funds to keep day-to-day business operational.

Insurance

Although you can’t get an insurance product that specifically pays out if you become insolvent, ensuring that you have the right cover in place for other business risks is a sensible step. If your business has unforeseen problems such as property or stock damage, legal claims or loss of income, the right insurance policy can reduce your exposure to financial losses.

Maintain good relationships with stakeholders

There are many stakeholders in a business which could affect the business’ liquidity and ability to avoid insolvency. Developing strong relationships with the following groups of people could enable you to negotiate your position if you find yourself struggling to keep up with your bills as they fall due.

Customers – explain that supply may be disrupted or prices may need to rise, either permanently or temporarily while you deal with the current financial situation.

Suppliers – renegotiate longer payment terms and improved prices.

Employees – keep lines of communication open with your staff and explain how they might be able to help during this period of uncertainty.

Investors – Reassure investors that you are implementing all available strategies to mitigate insolvency risk.

Bank – negotiate better payment terms and interest rates to reduce costs or increase your overdraft temporarily.

Prevention is better than cure

Your business health is critical for success. It’s always better to prevent issues from occurring in the first place than looking for a fix once the problem has happened. By actively putting in place risk mitigation measures, you’ll significantly reduce the chances of your business going insolvent. If this area of business contingency planning is unfamiliar to you and you would like to discuss your approach, get in touch on 0448 000 010, message me on LinkedIn or email me at Eddie@eddiesenatore.com.

Understanding Your Financial Position: How to Track and Assess Your Spending

April 17, 2023 By Eddie Senatore

Understanding Your Financial Position

Whether managing your or your company’s finances, understanding your financial position is the key to success and it’s simpler than you think. Whether you’re a small business owner or just trying to better manage your personal budget, tracking and assessing your spending is essential for staying on top of everything but it’s often overlooked. If you ever find yourself in a position where you’re losing track of expenses, your invoices don’t match or you’ve missed a payment, I’d strongly encourage you to take a step back and re-evaluate the immediate priorities. Once the dust has settled you’ll be in a better position to put robust measures in place to help you with day-to-day money management, moving forward.

How to Track Your Spending

Tracking and assessing your spending might seem like an overwhelming task to some – especially if you’re not used to keeping tabs on where your money goes. It can be a real shock to the system when you find yourself in a position where you have to start doing this suddenly, such as when starting a business. There’s a lot to keep track of – but the good news is that it doesn’t have to be complicated or time-consuming, that’s the thing. I completely understand if your immediate reaction to money management issues is to take on an accountant to straighten things out for you. Although taking on an accountant could potentially be an easy hands-off approach to a solution, it’s not always an accessible approach, especially when many businesses now operate on higher costs, lower margins and growing inflation.

Trust me when I say: having a good understanding of financial management can give you the confidence to make sound decisions with your money. Allowing you to plan for the future and make sure that your money’s working for you, as it should. With a clear understanding of your financial position, you can save time and energy, and avoid potentially costly mistakes and missed opportunities. Having control over your finances is incredibly empowering and you’ll find that this can help to boost confidence in yourself and your business.

Ways to Control Spending

It can be useful to think of cash as a ‘tool’ rather than as liquidity. Think about this: To insert screws into a board you’d use a screwdriver, to add nails you’d use a hammer. But what is all this talk about DIY and how does it relate to money management? Well, when you need to do a job at home, you generally use a tool to do it, but if you start hammering in screws and screwing in nails you’re going to give yourself a hard time. It’s not just about using the tool but knowing HOW to use it. Once you know how to use your ‘tools’ effectively; you’ll realize how they can be used to improve your business, or better yet: your quality of life. Let me explain:

Bring it back to basics: It might seem obvious but it’s often overlooked. One of the best ways to track and assess expenses is by creating a budget. A budget will help you identify exactly how much money you have coming in each month, as well as how much you need to cover all of the expenses: rent, bills and other costs associated with running a business (or living life!) should all be included. But think about it: If you can see at a glance what’s coming in and what needs to go out, you can use the data to help you: cut back costs, priorities and track your spending, among other things. The more you think about it the more useful it becomes. Use a spreadsheet to lay this out and automate calculations to eliminate human error where possible, if you don’t have a license for software some good online alternatives can be used for free.
Use a mobile app or software: There are plenty of great apps out there that make tracking and assessing spending easy. QuickBooks and Xero are two well-known examples of software that can be used to gain a deeper understanding of finances. Many people and businesses already benefit from the ledger and accounting solutions. Over time more people have come to adopt the software, encouraging developers to create more apps and software. Thankfully for you, this means you’re spoilt for choice when choosing the right app or software for you. Many suppliers offer free trials or free entry-level access to their platforms.
Use a cash flow forecast: You can add more detail to your budget by supplementing it with a cash flow forecast. Lay your income and costs out across a year and break this down by month, this works for both personal budgets and businesses. You’ll find that you can forecast most shortfalls before they occur. The easiest way to do this is to use accounting software but you can achieve the same output through Excel or Google Sheets. If you do use a spreadsheet, use formulas to auto-calculate values for you, it’ll save you a huge amount of time, effort and errors. Make this a ‘live’ document and regularly update it to incorporate changes in revenue and expenses so that you always have an accurate summary of the business and personal finances. The forecast can also be used to seek future investment, which will be subject to satisfactory profit, loss and cash flow forecasts.
Monitor regular expenses: Big ticket items such as manufacturing, rent, car and mortgage payments are all important to track. But there are additional areas of focus to gain a better understanding of where the money is going each month. Think lunches out, coffee runs, train tickets and Ubers. It’s important to pay attention to even minor expenses, they quickly add up over time if they’re not watched and managed. If possible, set up a system for tracking all costs so that it’s easier to monitor spending in real time, some commercial banks provide this and some apps can be integrated into your account’s API that’ll enable you to auto-track expenses to predetermined criteria.
Separate business from personal: By separating your business and personal finances, you’ll be better placed to track expenses, income, and profits, it’ll also make it easier to identify areas where you can save some money and could help to minimize personal liability for business non-compliance. It’s worth noting that this is subject to local corporation laws and that separating business from personal finance doesn’t by default minimize personal liability in and of itself.
Set financial goals: Setting financial goals is an incredibly useful tool and it can be used to inform, provide structure, influence decision making and motivate. When setting goals, consider your desired income level, desired saving rate, desired rate of return, and desired debt-to-income ratio, and implement strategies to achieve the desired output.
Draw up and implement a finance strategy: Develop a financial strategy to get the most out of your business finances. The strategy can include your budgeting system, ways to reduce expenses now and in the future, ways to increase revenue, and ways to manage debt. Your strategy should also include steps to ensure that you’re meeting your financial goals through KPIs and that you’re staying within budget.
Review once per quarter: A regular review is essential. At least once a quarter is a good rule of thumb to ensure that all your financial information is up-to-date and accurate. Take your time and be thorough. Identify opportunities to save through reducing, eliminating or consolidating services and expenses. All income and expense sources should be considered so that you can see the full picture. Investments, savings and dividends should count towards your income and ensure you’re anticipating your sundry items. Start with your financial statements: your budget, cash flow forecast, balance sheets and bank account statements can all be used to gain a better understanding of the company’s current and future financial position.

Once you’ve determined the most suitable methods for you, determine the level of complexity you need. To do this: consider your desired output. What do you need? Higher margins? lower income to debt ratio? If you want to raise your margins it might be worth conducting a cost analysis as part of your budgeting. If you want to lower your debt-to-income ratio, you can analyze your current debtor payment schedules for opportunities to pay down debt faster.

To simplify a method you could, for example, create a cash flow forecast but do this to the first quarter of a given period, rather than provide an annual projection. In relation to software and mobile apps, there are also varying levels of complexity depending on your individual needs and the needs of your business. Budgets, cash flow forecasts and financial goals can all be created with software and typically simplify the process, especially in the case of cash flow forecast creation and other financial projections.

Overall, adopting any of the above will be a positive step towards understanding your financial position and will empower you to better track and assess your spending when implemented effectively.

Proactive Measures for Businesses to Prevent Insolvency