In an uncertain economic climate, financial distress rarely appears overnight. More often than not, it develops gradually, leaving behind a trail of warning signs that can easily be overlooked by businesses focussed on maintaining day-to-day operations and commercial relationships.  In this article we help identify signs of financial distress in your business and in those you do business with. It is crucial to recognise financial distress early to implement effective strategies.

Whether dealing with suppliers, customers, or other counterparties, failing to recognise these indicators early can expose a company to significant financial and operational risk including supply chain disruption, bad debt, contractual disputes, or even insolvency-related losses. By recognising the signs early and responding appropriately, companies can protect cashflow, preserve commercial stability and make informed decisions about ongoing business relationships. When businesses are at risk of financial distress, identifying it as soon as possible is therefore essential for all companies.

Recognising Financial Distress

Drops in revenue can destabilise a business when they reduce cashflow faster than the company can adjust its costs, operations or financing. The main causes usually (but not always) fall into a few broad categories – 

  • Loss of customers – key clients leave, contracts are lost (even one major contract alone can lead to a sharp and substantial reduction in income) 
  • Reduced demand – economic downturns, energy price rises, changing consumer preferences, seasonal weakness as well as financial distress driven by these factors.
  • Increased competition 

Directors should investigate the cause, adjust budgets and identify opportunities to diversify income streams, which helps to minimise the risk of financial distress.

The key to mitigating financial risks is being able to recognise the insolvency warning signs whether this is of your supplier, customer, guarantor or other counterparty.   

However, before we even reach this stage, there are various checks that can be carried out and safeguards that can be put in place to protect against finding yourself facing losses that flow from the insolvency of a supplier or customer. In other words, frontload the due diligence process. These include:  

At the outset of any contractual relationship, assess whether you are dealing with a viable and financially sound business – 

  • request latest set of accounts 
  • carry out a company search at Companies House to check for any warning signs of financial distress.
  • search the Winding Up Register 
  • London Gazette search 
  • County Court judgment search, 
  • Market intelligence / data 

Upon entering a contractual relationship: 

  • Ensure your contracts and terms of business have been reviewed and contain the appropriate provisions entitling termination of the contract in the event of default (paying particular attention to definition of ‘insolvency’ and ‘event of default’) to safeguard against financial distress.
  • Ensure contracts include retention of title clauses 
  • Keep on top of credit control – “Cash is king” 
  • Seek personal guarantees wherever possible and ensure these are properly executed  
  • Take a proportion of the fee upfront, if possible  
  • Register at Companies House to ‘follow’ a company; (check the filed accounts for “at risk” companies) 

There are various warning signs to look out for to pre-empt insolvency. These include: 

  1. Customers persistently paying invoices late, reducing order values or seeking extended credit terms are all warning signs that may indicate financial distress.
  1. Suppliers struggling to fulfil orders, delaying deliveries or demanding changes to payment terms 
  1. Poor or no communication  
  1. Invoices settled by unconnected parties  
  1. Delays in filing statutory accounts at Companies House 
  1. Repeated poor trading figures (check the filed accounts at Companies House for “at risk” companies) 
  1. Becoming aware of a possible company voluntary arrangement (CVA) 
  1. Negative press coverage 
  1. Management instability and redundancies which sometimes result from financial distress.
  1. Companies House Notice of compulsory strike off. 

One of the key reasons for being alert to and/or protecting against financial difficulty is that post company insolvency, the options open to a creditor business for recovery of losses are limited as there are often little/no assets and no cash. 

There are other ways to potentially recoup monies owed – recovery under personal guarantees for example. If you find yourself facing such a situation, we can explore the options available with you. Moreover, understanding how to respond to financial distress can make a significant difference for your business.

Farringford Legal’s head of restructuring and insolvency, Tania Clench can advise all businesses on dealing with financial distress early.