In today's fast-paced business world, financial distress can creep up on companies, large and small, without warning. Conducting a company credit check can provide valuable insights into a company's leadership and financial health.
According to insolvency experts, there has been a record jump in the number of UK businesses in critical financial distress. In the fourth quarter of 2024, 46,583 UK companies were in critical financial distress, a 50% increase from the previous quarter.
Recognising the signs early can be the difference between taking timely action and facing severe financial consequences. This is not just true for companies that are in financial distress, but also for companies that are deciding on potential partners to work with, whether that is to lend credit or to secure a vendor.
With Company Watch, you can conduct a company credit check that can reveal crucial information about a company's financial health.
This article will guide you through the key indicators of financial distress in your own or another firm, and offer strategies to assess a company's financial health effectively.
Understanding financial distress
Financial distress occurs when a company struggles to meet its financial obligations. This can lead to serious issues, including business insolvency, bankruptcy, or even closure. Any company credit check on a distressed business will show the company should not receive credit or be worked with.
Once a company is in financial distress, the due process typically involves the following steps:
- Directors must reassess their duties, shifting focus from shareholders to creditors' interest.
- The company should seek professional advice from legal and financial experts to evaluate options.
- The company may explore restructuring or turnaround options, such as:
- Seeking a moratorium to protect the business from creditor actions.
- Negotiating with creditors to restructure debts.
- Considering a Company Voluntary Arrangement (CVA) to propose a compromise with creditors.
- If recovery is not possible, the company may enter formal insolvency processes:
- Administration - an administrator is appointed to manage the company and explore recovery options.
- Liquidation - a liquidator is appointed to sell assets and distribute proceeds to creditors.
- Throughout this process, directors must be cautious to avoid personal liability for wrongful trading or breach of duties. This may be flagged in a UK company director search or company credit check.
Identifying the signs of financial distress early can help businesses take proactive measures to mitigate risks and improve their financial standing.
Key signs of financial distress
Recognising financial distress involves understanding a variety of indicators. Here are some of the most common signs:
1. Declining revenue
A consistent drop in revenue is one of the most apparent signs of financial distress. If a company you’re monitoring is experiencing a downward trend in sales without a clear reason, it might be time to investigate further.
2. Increasing debt levels
Rising debt levels, especially when coupled with decreasing revenue, can signal financial trouble. According to the latest data from the Office for National Statistics (ONS), as of early January 2025, around 25% of UK businesses reported experiencing debt challenges. This would significantly impact any company credit checks that may be conducted by potential partners or creditors.
High-interest payments and the inability to pay off debts can strain a company's resources.
3. Cash flow problems
Cash flow is the lifeblood of any business. If a company is struggling to manage its cash flow, it could indicate underlying financial issues. This might manifest as delayed payments to suppliers or difficulties in meeting payroll obligations.
Of course, all businesses face cash flow problems from time to time. That doesn’t necessarily mean that they are in distress. However, persistent cash flow issues over a long period of time are a major red flag.
4. Poor profit margins
When profit margins shrink, it suggests that a company isn't generating enough income relative to its expenses. This can be a warning sign of ineffective cost management or declining sales. A company credit check will flag this to any potential creditors.
5. Frequent changes in management
High turnover in management or frequent restructuring can be indicative of underlying financial problems. It may suggest instability within the company, which can affect its financial health. To that end, a UK company director search can flag any management changes that could be potential red flags.
6. Negative working capital
Working capital measures a company's short-term financial health. Negative working capital, where liabilities exceed assets, can be a red flag for financial distress.
Mainly, poor management of working capital can be a barrier for companies to invest in profitable projects, potentially triggering bankruptcy.
Strategies for addressing financial distress
For companies undergoing financial distress, it's essential to take corrective action once signs of distress are identified. Here are some strategies to consider:
Cost reduction
Reviewing and reducing unnecessary expenses can help improve cash flow and profitability. Identify areas where costs can be trimmed without compromising the quality of products or services.
Follow this 3-step rule for cutting costs:
- Review finances - analyse your spending to see where your money goes.
- Assess expenses - decide what's essential vs. unnecessary.
- Target and act - prioritise big expenses, set reduction goals, and implement changes.
Essential expenses drive revenue, support core operations, and enable growth. They directly contribute to a company's strategic objectives and competitive advantage, like core staff and key materials.
Unnecessary expenses don't significantly impact revenue or growth. Often stemming from inefficiencies, they include things like excessive travel or underused subscriptions.
Restructuring debt
Negotiating with creditors to restructure debt can provide relief from financial pressure. This might involve extending payment terms or reducing interest rates. This will also improve your standing during a company credit check.
According to a Harvard study of 169 financially distressed companies in the US, about half successfully restructured their debt outside of Chapter 11 bankruptcy. This shows that debt restructuring can be an effective method for companies to address financial distress without resorting to formal bankruptcy proceedings.
Monitoring companies in financial distress
The Company Watch platform offers several tools and features to help businesses monitor companies in financial distress. Our comprehensive company credit check ensures that no stone is left unturned in the due diligence process. The company credit check comprises various key metrics.
Our H-Score® measures a company's financial health on a scale of 0-100, with scores of 25 or below indicating potential financial distress. It analyses various aspects of a company's financial position, including profit management, working capital, liquidity, and asset funding.
In addition, our TextScore®, uses advanced machine learning techniques to analyse the text in financial reports of publicly listed and large private UK companies. It searches for linguistic patterns similar to those used by companies that subsequently failed, providing a score between 0-100 to predict the probability of corporate distress.
Together, the H-Score® and TextScore® allow you to stay ahead of financial risk. The provide early warning indicators of potential financial distress, enabling proactive decision-making and risk management strategies.
