Dr Keen Mhlanga
It is not entirely unusual for a company to face financial difficulties. The sooner you identify the underlying issues, the better your chances of resolving them.
When a company becomes insolvent, it is unable to repay debts and meet financial obligations as they come due. A company is also said to be insolvent if its liabilities (debts) exceed its assets (the things it owns).
When directors are preoccupied with the day-to-day operations of their company, it is all too easy to overlook warning signs of impending insolvency.
You may simply attribute cash flow issues to an inefficient department or function of the business, rather than taking a broader view of operations as a whole.
“You have to spend money to make money,” as the adage goes. It is normal for most business owners to try to extend credit terms provided by their trade suppliers. However, if you are unable to pay your creditors on time, particularly your employees, the Zimbabwe Revenue Authority, secured creditors or lessors, and your landlord, this is likely a sign that your business is unable to settle its obligations in the regular course of business and it could be insolvent.
When a company reaches the limit of its bank overdraft and is refused further borrowing without providing guarantees.
Also, if suppliers refuse to extend credit to the company and it lacks sufficient assets to obtain a secured short-term loan. If company transfers fail, it will create additional issues with suppliers, who may decide to take legal action in the form of a statutory demand.
Businesses, particularly start-ups, frequently accrue operating losses. Matter of fact, some businesses intend to lose money in order to gain market share, for example. When you haven’t budgeted for losses, or much worse, don’t recognise why your company is losing funds, you have a dilemma! Continuing and significant losses adversely affect working capital and, aside from a negative value at the bottom of your income statement, lead to an adverse number on your financial statements.
Numerous businesses have a few very loyal clients which can be great. However, you need to think about the consequences that losing a good customer might have on your business. Furthermore, losing a future sale is one thing, but what if a major customer goes bankrupt and you have to write off a large account receivable? Accumulation of sales and accounts receivable could indeed lead to insolvency if a substantial customer is lost.
Many business owners regard accounting as an afterthought. They appear to believe that they intuitively understand how their business is performing. However, the descent into financial distress is often slow and insidious; you may think you’re making a profit, but you’re actually losing money on every single transaction.
Alternatively, you may be making a gross profit, but it is being eroded by administrative costs. A well-functioning business requires timely, accurate, and consistent financial information. Maintain vigilance over key performance indicators.
If there are no structures in place to just provide critical information about the business’ performance it will be a red flag. Cash flow forecasts, aged debtor reports, bank reconciliations, and sales forecasts are all required for directors to make confident decisions. Without this information, it is impossible to say with certainty how much you owe and the extent of your debt. The company is in a dangerous situation because its relief possibilities are highly restricted.
If somehow the chances of meeting the payroll are slim, it is a sure sign that insolvency is imminent.
You may not have taken a salary from the company for a few months in the hope that the next big sale will correct the situation, but this is very rarely the case, and once employee wages go unpaid, your company is technically bankrupt.
The loss of employees can be indicative of a variety of problems. Is a competitor in your market stealing your best employees? Is your staff noticing a problem that you aren’t? High staff turnover is expensive in terms of recruiting and training new employees.
New employees are frequently inefficient at first, make more errors, and may need to establish relationships with your customers, a process that can be expensive and risky.
Growing your business by increasing sales is a common goal, but you must consider whether those increased sales are profitable. Furthermore, growth necessitates the expenditure of resources. Those extra sales could lead to an increase in accounts receivable. You may need to carry more inventory in order to make those new sales. This necessitates more funds.
Is your company a plaintiff or defendant in any legal proceedings? Will you require the services of a lawyer? Lawyers are expensive, and any type of legal action diverts your attention away from running your business. It is usually best to try to resolve issues early before they languish and grow. Also, be mindful that under certain instances plaintiffs can seek court rulings to freeze your assets or necessitate that you compensate funds into court. This will squander your working capital on non-productive activities.
Cash flow is critical to the success of any business. It is the business’s lifeblood, and without it, it is difficult to pay salaries, order products, and advertise. Getting the money you needed to complete a task was never a problem in the past. It’s now a struggle. Your request for new supplies has been denied. Pay raises are no longer available. People are asked to take pay cuts or, worse, work for free — furloughs are very real and very frightening.
The bills have not been paid. Vendors call you upset because they have not received the money they are owed. These are all classic indicators of serious financial difficulties. They are usually followed by the doors being permanently closed.
If your company becomes insolvent, you have an obligation to prioritise the interests of creditors over your own.
This may imply that you must immediately cease trading in order to prevent your company from incurring additional debt, lowering its value.
An insolvency practitioner will be able to assess whether the company should cease operations or continue operations if doing so will improve the return to creditors.
Dr Keen Mhlanga is an investment advisor with high skills in finance. He is the executive chairman of FinKing Financial Advisory. Send your feedback to [email protected], contact him on 0777597526.