The past couple of years have been a very challenging time for many small to medium-sized agencies in the creative, marketing and PR sectors. Running Magic Digits and working with about 40 agency businesses, I’ve learned to recognise the warning signs of insolvency, and I thought it might be helpful to share them with you so you can recognise them in your business too.
Being able to detect the warning signs of insolvency early can be the difference between a successful turnaround and a financial collapse. Financial health is crucial for the survival and growth of any business. A business on the road to becoming insolvent will often present with warning signs well before it runs out of cash and reaches a point of no recovery.
Here are some key indicators that your business is heading towards insolvency:
Liabilities Outweigh Assets
If the debt-to-asset ratio is exceptionally high, the business may be unable to raise enough money to pay off its debts and lenders may reduce borrowing to a business with a high debt to asset ratio. At Magic Digits the first thing we check when we work with a new client is the balance sheet to assess this. We will address how to understand your balance sheet in future blog posts, but this short post from agency advisor and fractional CFO Simon Collard is useful.
Unusually High Overheads
Businesses naturally have operational expenses, but an unusual spike in overheads can indicate financial trouble. Regularly review your fixed and variable costs. Our target for most agency business is for overheads to be 20% of their total fees each month. Rising costs without a corresponding increase in revenue can affect your profit margins and contribute to insolvency.
Consistent Cash Flow Problems
One of the most glaring signs of potential insolvency is persistent cash flow problems. If your business frequently struggles to cover day-to-day expenses, it could indicate that your revenue isn’t keeping pace with your expenditures. Watch for issues such as delayed payments to suppliers, payroll delays, or increased reliance on credit to manage cash flow gaps.
Borrowing as a Life-line
While some level of debt is typical in business operations, excessive or increasing debt levels can be a red flag. If your business mostly depends on multiple lines of credit as its primary source of funds, it’s unlikely to be able to survive without this support.
Declining Sales and Revenue
A sustained drop in sales and revenue can jeopardise your business’s financial stability. If you notice a downward trend in your sales figures or a reduction in revenue despite consistent or increasing expenses, it may be time to reevaluate your business strategy and market positioning. You may need to cut costs in line with your declining revenue, and wait for an improvement in business or market performance.
Overdue Tax Bills
The business will be held responsible for old and historic tax bills, so if these are ignored they become unaffordable and HMRC may send you a winding up order if they have suspicions that the company may be insolvent. HMRC will also impose penalties and interest for overdue tax bills.
So, that’s the fun stuff covered! Seriously, all of this doesn’t need to be the “death knell” for your business. If you’re able to spot these signs early, you have the time to respond.
You can take action and steer your business away from the choppy waters of insolvency to the safe harbour of an ongoing concern. Here’s how:
Seek Professional Advice
Consult with financial advisors, accountants, or insolvency practitioners to get a professional assessment and guidance on how to address your financial challenges. Am I talking my own book? Maybe! But the benefit of external advice is to have accountability and perspective from someone outside of the business. I’m a founder myself and I know the emotional attachment I have to my third child, Magic Digits (Halia and Hudson are the other two I worry about most, not necessarily in that order). Cool, calmed, more detached advice from someone who’s been there before can really help, when it matters most.
Improve Cash Flow Management
Implement strategies to improve cash flow, such as improving credit control, negotiating better payment terms with suppliers, and reducing unnecessary expenses and keeping on top of cash flow on a more regular basis. Monitor the average number of days it takes you to collect cash from your customers, and set yourself a target of reducing that number each month. Do NOT fall into the trap of just managing your cash by your bank balance each day, week or month. Forecast your cash flow for the next six to twelve months so you know when you’ll have big hits from HMRC. One of the core parts of the Management Accounting pack we deliver our clients at Magic Digits is a robust future cash flow forecast. It’s an invaluable tool - am I talking my own book again?!
Reevaluate Business Strategies
Reassess your business model, market positioning, and revenue streams. Can you drive more revenue from your existing customers? Can you turn your one-off projects into ongoing retainers? Can you work your personal and professional network a little harder to drive more opportunity for the business? Adjusting your strategy to increase your revenues and approach may help stabilise your financial situation.
Communicate with Stakeholders
Maintain open communication with creditors, employees, and other stakeholders. Transparent communication can help manage expectations and facilitate negotiations. Creditors will usually be more understanding and provide you more lenient terms if you are honest, open and transparent with them about when they will get paid. If you aren’t, or if you don’t pay them when you’ve said you will, you may get unwanted and unhelpful knocks on the door…
Early intervention can often prevent a business from reaching the point of insolvency. By staying vigilant and addressing warning signs promptly a business can navigate financial difficulties more effectively and work towards a stable, successful future. Set shared KPIs and commitments around cash, cash flow management, revenue and costs, and track these each month. There’s magic in the digits, trust me.
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