The worst thing you can do as a company director when financial problems arise is to ignore them. Capable directors know the warning signs and their relative severity, understand their duties and responsibilities, take decisive action when needed and are aware of potential restructuring options. Ian Barrett in KPMG's Restructuring Team, sets out what you need to know.

While many Irish businesses have avoided insolvency since the onset of the pandemic with the help of government supports, tax warehousing and patient creditors, the environment has changed. The supports have ended and businesses face extensive uncertainty due to inflation, interest rate rises, supply chain challenges, and other challenges.

The result? Increased running costs, higher costs of debt, potentially reduced demand and output disruption. Not only that, but the artificially low rate of insolvencies we have seen in recent years is also set to rise.

"Cash flow difficulties are the canary in the coalmine for businesses...due to falling sales, the loss of major customers, debtors paying late or trading losses."

Know the warning signs of financial distress

While every business that ends up in financial difficulty faces unique circumstances, we see common issues arise frequently. When these issues build up and a company’s board doesn’t take decisive action, it can easily become too late to explore feasible restructuring solutions.

It’s vital to be aware of the warning signs and take rapid action if you see them.

Early-stage warning signs

Cash flow difficulties are the canary in the coalmine for businesses, whether those are due to falling sales, the loss of major customers, debtors paying late or trading losses. Other early signs to watch out for include:

  • poor liquidity ratios
  • overdrafts always at their limits
  • directors not taking a salary
  • credit terms being stretched

Mid-stage warning signs

Tax arrears building up or returns not being filed is a serious red flag for any business. The same applies if refinance applications are refused, large bad debts are being written off or the company is in dispute with its auditor.

Likewise, directors should immediately be concerned by any issues with creditors such as:

  • rent or other essential services being unpaid or delayed
  • being put on stop supply, stop credit or cash on delivery terms
  • being put on repayment plans or paying in instalments
  • facing demands from uncontested creditors

Late-stage warning signs

Directors should be extremely concerned if they learn the company is not paying or is late paying staff wages or has received an eviction notice from its landlord.

If cashflow projections show a current shortfall cannot be funded or a market assessment shows there is little appetite among other firms to buy part or all of the business, it should also be a cause for alarm.

Similarly, it’s a matter of utmost urgency for directors if they discover the company has received any of these:

  • Tax arrears notices or demands from the Revenue Commissioners
  • legal demands or judgement debts
  • a petition to wind up from a creditor
  • creditor requests to have stock returned under retention of title, meaning the creditors were not paid for the stock and still own it

How to respond to financial difficulty

The first thing to do is to analyse if the business is viable and can trade out of the difficulty.

Ensure you have detailed and properly stress-tested 12-month financial forecasts in place. Managers and directors can then review it regularly, make informed decisions and address any issues quickly.

Hold regular board meetings to monitor trading performance and use a board pack containing accurate, up-to-date information on cash flow, trading projections, creditor balances and commitments given, funding and so on.

It’s also vital to be able to show strong corporate governance. Make sure the board keeps detailed minutes and can point to a clear paper trail relating to critical decisions.

If you’re a company director and you’re worried about the company’s financial position, seek professional advice immediately around your legal obligations, potential consequences for you personally and the business, and potential solutions for the financial travails.

"Two tests that determine whether a company is insolvent are the Cash Flow test and the Balance Sheet test."

Insolvency: What is it and how to avoid it

Is your company insolvent?

Two tests that determine whether a company is insolvent are the Cash Flow test and the Balance Sheet test. In terms of the cash flow test, the question is can a company pay its debts as they fall due. The Balance Sheet test is whether the company has sufficient assets to discharge its liabilities or, in other words, the company is insolvent on a Balance Sheet basis if its liabilities exceed its assets.   

Ways to avoid insolvency

To ensure close and continuous oversight of the company’s financial position, the board must prepare regular, detailed cash flow projections, as outlined above, and be clear on the funds needed to stay in business. 

When it comes to assessing the financial position and applying the above tests, you should always consider:

  • Can the company trade out of its financial difficulties?
  • Why are we underperforming or having  liquidity problems?
  • What are the company’s prospects over the medium and long term?
  • What does the business need to stay afloat?
  • Could we or should we sell part of the business or some assets to generate funds?
  • Could we raise finance or refinance our secured debt?
  • Are we being threatened with enforcement by creditors?

If the company is unsure of whether it can answer the above, it should immediately seek professional advice on what options it has available.  

What to do when insolvency looms

Know your obligations in insolvency

Normally, as a director, you have clear duties under the Companies Act 2014. These include acting honestly, in good faith and in accordance with the company’s constitution.

When a company is insolvent, however, you must also have regard for the interests of the company's creditors. Significantly, recent EU Regulations mean this is a statutory obligation for the first time. In other words, the European Union (Preventive Restructuring) Regulations 2022 are enforceable in the same way as the traditional fiduciary duties of directors

If a company goes into liquidation, for example, its board of directors must be able to show the liquidator how it tried to act in the best interest of its creditors. 

Avoid common mistakes and safeguard your position

Along with not following the advice above, directors should also strive to avoid other common errors in insolvency or times of financial difficulty. Those can include, for example:

  • failing to consider the appointment of an Examiner, Liquidator or Process advisor
  • not seeking professional and legal advice
  • trying to trade out of insolvency when that’s not the right course of action.

Directors who don’t uphold their duties and obligations can end up being restricted or disqualified from being a director. Furthermore, they can be made personally liable for the company’s debts if it can be shown they acted recklessly or fraudulently, or they did not try to ensure the company kept proper records.

Understand restructuring options

When a business gets into difficulty, it can affect lenders, creditors, other companies and individuals. In our experience at KPMG, we see early intervention considerably increases the chances of a positive outcome. 

One valuable path for potentially insolvent but viable small and micro companies is the relatively affordable Small Company Administrative Rescue Process (SCARP). As with examinership, this is a formal insolvency process that allows a company to restructure its debts and continue to trade.

There are also multiple other restructuring options for business, including examinership and different types of liquidation. 

Get expert advice

At KPMG, we have extensive experience in advising underperforming businesses how to restructure and turn things around. We use our technical knowledge, commercial insight and strategic know-how to identify the root causes of the issue and devise a plan to resolve it.

Talk to us today if you’re concerned about the financial prospects of your company or would like to ensure your board is following best practice. 

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