Sink or swim: navigating the decline curve of a business

Understanding the decline curve of a business is vital to ensure that you can respond appropriately and protect your own position in times when customers, tenants or suppliers are facing financial difficulty. Uncertainty within the UK economy, as a result of rising interest rates and record levels of inflation, driven by global factors such as the ongoing impact of Covid and the war in Ukraine, has increased pressure on businesses and unfortunately made insolvency (the inability to meet debts as they fall due) more likely.

This article looks at the warning signs that indicate that a company may be heading towards insolvency. Some of the key red flags to look out for are:

  • Late payments or requests for extended credit terms
  • A change in business procedures (e.g. payment or supply terms)
  • High employee turnover and under-resourced staff
  • Unusually slow responses to communications
  • Reputational issues in the market

Phases of decline

Business decline can broadly be categorised into three phases: underperformance, distress and crisis. If early action is taken, an effective rescue and restructure can be viable. However, a failure by the business to address the early warning signs can accelerate its decline, and an external shock can expedite this process further. Below, we highlight key indicators of financial distress to look out for at each stage.  

Underperformance

A decline in reputation and market perception – The first red flag that a business may be facing financial difficulty is if the market it operates in loses confidence. Businesses rarely operate in a vacuum and those closest will be the first to become aware of problems. Rumours and talk in the market can be an early indicator that things aren't perhaps running as smoothly as they once were and could highlight the need to be on alert for further signs. As soon as you become aware of potential difficulties, consider the key steps you might be able to take in order to safeguard against your own financial risk.  This might include enhanced credit control or greater communication.

Falling gross profits – Gross profits declining may indicate that a company is either generating less revenue or its production costs are increasing. A particular red flag to look out for here is late filing of accounts, which may indicate the company is trying to avoid publicising their financial difficulty until absolutely necessary.

Relaunching and rebranding – If a company adopts a strategy to relaunch and rebrand, the reasons behind that should be investigated. If this process is unexpected or appears to have been hurried or poorly thought through, it may be an indicator of a reputational issue with the old brand or a short-term attempt to boost revenues with a fresh look.  

Distress

Breaches of contract and credit terms – Taking longer to pay, delays in supply and exceeding terms of credit are all potential signs that a business is experiencing rough financial tides. At this stage, it may be appropriate to review and/or take advice in relation to your rights pertaining to termination and performance obligations. You may also wish to take this as an opportunity to make enquiries with the business in order to determine the wider factors that may be relevant to its underperformance.

Businesses becoming more contentious – Poor cashflow places stress on a business, which may lead it to employing more draconian debt collection measures, such as issuing more regular payment statements to customers, raising disputes in relation to supplies or using external debt collection services. This increased urgency to chase debt or avoid payment can signify distress.

Crisis

Resignation of employees– Keeping up with personnel changes can ensure you are informed if a crisis is looming. In particular, look out for resignations by key employees, such as those with financial responsibilities, which may indicate the bubble is imminently about to burst and employees are abandoning a sinking ship.

Suppliers refusing to supply goods or extend credit – If others in the market refuse to trade with a business, or withdraw credit facilities, this is a key indicator that a crisis is near. These steps indicate that there has been a failure to address short-term financial problems, and the resulting disruption to the business's supply chain is likely to mean that it will struggle to stay afloat and continue operating.

Conclusion

Financial difficulty is best addressed at an early stage when the options available are more wide-ranging. The warning signs highlighted above are indicators that hurdles may be around the corner. Early recognition of these signs appearing in relation to suppliers and customers will allow you to take pre-emptive steps, including seeking legal advice in relation to the options available to you, and protecting your own financial position at this uncertain time.