What do we look for when we consider the risk of financial distress?
A recent review of a sample of ten companies showing signs of being “at risk of financial distress” found five had an “emphasis of matter” in their auditor’s report, and the other five had one or more of the following risk factors:
- low levels or no financial reserves
- staff redundancies
- downsizing premises
- negative pension funds
- falling margins
- increasing bad debts
- poor cash flow
You may think insolvency as a “risk factor” is self-fulfilling. However, the point for business owners is to realise you need to act far earlier on warning signs.
Remember that the governance of any entity involves financial risk and personal liability for a sole trader, partner, or director.
An independent external voice can greatly assist the SME owner in these matters. Whether it is a non-executive director, your accountant or even a trusted friend, having someone who can take an overview can be vital.
Can you trust yourself not to get bogged down in the details and recognise that you have problems? Even if you do see the issues, will you act on them in a timely fashion?
Early warning is vital, which is why proper management accounts – preferably measured against a sensible budget – are so helpful. Remember also that a budget is not a target.
Too many people set unrealistic budgets based on little more than a wish list. A budget should be something that realistically can be achieved. A target is something to aim at.
I appreciate that there may be a cost to outside advice. But in contrast to the cost of insolvency or personal liability, it is a cost which is well worth incurring.