Insolvency is a little bit like weight gain. Everything seems fine, and then one day, you suddenly find you cannot zip up your jeans. “How did that happen?” you wonder. Then the memories of too many cakes and biscuits eaten come drifting back. Likewise, when one day you find your business account desperately short of cash and supplier invoices and loan payment demands piling up, you may feel like the situation happened without notice. However, insolvency always comes with warning signs, and one of the most critical risk management strategies you need to implement is policies and checks to ensure your company is not only solvent but has enough cash reserves to survive if an unexpected disaster strikes.

What is insolvency?

There are two ways to measure insolvency:

• the cash-flow test: asks if the business is currently, or will it in the future, be unable to pay its debts as and when they fall due for payment?
• the balance sheet test: asks if the value of the business’s assets is less than the amount of its liabilities, taking into account as-yet uncertain and future liabilities.

The balance sheet test is concerned with whether the business can sell assets to liquidate cash to pay its debts. If the assets cannot be sold the business can still be deemed insolvent, even if its assets are greater than its current and future liabilities.

What can I do to protect my business against insolvency?

All businesses face the possibility of something happening that no one could have predicted in their wildest dreams – hello Covid lockdowns. However, part of a business owner’s job is to ensure their company can survive ‘unprecedented’ situations such as war, pestilence, Acts of God, and the next economic crisis. We put the term ‘unprecedented’ into quotes because a glance through a few history books will confirm that there is nothing unprecedented about human conflict, disease, high inflation etc – they have been part of the commercial world since our neolithic ancestors first began to trade furs, food, and weapons.

Below are five ways you can manage your insolvency risk.

Have the right insurance

When you first opened your business, you probably insured your stock and took out public liability and employee liability insurance. However, many people forget to update their insurance policies as their operations grow. Underinsurance is a chronic problem and can cost you thousands (if not millions) of pounds. To avoid falling into insolvency following a disaster, make sure you review your insurance portfolio annually.

Another critical insurance product that people often miss is business interruption insurance. This will cover your expenses if you cannot trade for a period due to a fire or flood.

Watch your cash-flow

Monitoring the amount of liquid cash you have available is an essential risk management strategy. This involves ensuring your invoices are paid on time and slow payers are chased up quickly and effectively.

It is best practice to track your cash. This is typically done by creating a cash flow balance sheet that shows the cash coming into your business and cash going out to pay overheads and investments/assets.

It is important to monitor your cash flow in order to spot trends, for example, customers who are constantly late in paying their invoices or suppliers who regularly put up their prices.

Build a relationship with your creditors

Despite having the best risk management strategies in place, sometimes circumstances conspire against you. If your organisation is going through a tough time or you have overextended in terms of purchasing assets or an M&A, being able to approach your creditors and negotiate alternative payment arrangements can save you many sleepless nights. But to do this, it is essential to treat them well during good times. By nurturing good relationships with those who supply your business, you are more likely to get a positive response if you need to ask for a few months of breathing space whilst you build your cash-flow back up.

Diversify your revenue streams and customer base

The old cliché “never put all your eggs in one basket” rings true when it comes to avoiding insolvency. If one customer or product line provides a substantial part of your revenue, your company risks going belly up if they suddenly cancel their orders or people stop wanting to purchase that particular good or service. Keep your business dynamic by seeking out new markets, developing new products, and expanding your customer base. Monitor your sales to ensure you are not relying on one or two customers or products for a bulk of your turnover.

Treat your customers like gold

All businesses proclaim that their customers are their number one priority. Still, a quick trip down your local High Street will most likely confirm your suspicions that customer service and experience is something often talked about but seldom practised.

One of the oldest and most true pieces of business advice is that it is far cheaper and easier to retain an existing customer than to find a new one. Therefore, part of your risk management plan should focus on training staff to provide exceptional customer service and embed an attitude of customer care and experience into the company’s culture.

Wrapping up

A robust risk management plan can protect your organisation from falling into insolvency. By having policies such as a cash-flow forecast, customer care, and debt recovery plans in place, you can keep your finances and brand in a strong position so it can survive tough times when they come.

To find out more about how our Virtual In-House Legal Counsel can assist you with risk management policies and procedures, please email us at [email protected] or phone 0121 249 2400.

The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article, please contact 43Legal.