Published on February 24th, 2023
It’s no secret that the post-COVID economy is a tough one with the initial recovery being reversed by a fresh wave of challenges, such as international supply chain delays and sky rocketing energy costs. Since the start of 2022 the number of business insolvencies has been steadily rising and is now reaching record levels. The knee jerk assumption is that this rise is mainly due to the many well publicized economic crises driving up costs and reducing profits, making it impossible for businesses to stay open.
Whilst these do have an effect, one of the most common causes of insolvency is bad debt.
When a company goes insolvent, also known as bankruptcy, their assets are sold and the money distributed to their creditors, people they owe money to. This distribution is not equal and in the majority of cases these funds go to whatever financial institutions are owed money and businesses that are owed money get little or nothing; this is known as bad debt. By losing this expected income many companies go insolvent themselves.
The good news is that there are several steps companies can take to reduce the risk of bad debts: chief amongst them is by employing enhanced due diligence.
Enhanced due diligence is where a company researches any potential business partner before doing a deal and extending credit. If any signs of risk of that company going insolvent are found then no credit is offered and the potential bad debt is avoided. Employing enhanced due diligence is one of the most powerful methods a company can use to not just survive but thrive.
Let’s look at 5 signs of risk to look out for whilst performing enhanced due diligence.
1. A Company Has Filed Its Accounts Late
Every company is required to submit their annual accounts to Companies House, who then make them publicly available. This is done to increase transparency and allow companies to do due diligence on potential business partners. A company that is struggling may intentionally delay filing their accounts so they can include extra income or merely prepare for the fallout that publishing a bad set of accounts will cause.
If a potential business partner is late in publishing their accounts this is a major sign of risk of them becoming insolvent. Similarly, if they have a history of late accounts then they may be surviving month to month and are therefore a risk.
2. Directors Are Leaving The Company
When a company is at risk of collapse it is common for the majority of directors to leave. They are usually the first to know that the company will ultimately fail and will leave to either avoid association with its collapse or find new employment.
If a potential business partner has lost directors within a short space of time this should be considered a good indication that the company is a risk.
3. The Company Has Experienced Bad Debt
It is a sad fact that a company experiencing a bad debt through one of their debtors going insolvent is at risk of going insolvent themselves, three times more at risk than a company that has not, in fact. In many cases these might be otherwise good companies but the pressure of losing key income is too much to bear.
A company experiencing bad debt is one of the largest signs of risk and doing business them should be approached with extreme caution.
4. The Company Has A Poor Payment History
The definition of a company being insolvent is when its assets are not enough to cover its liabilities (debts) and as such a company that is at risk of collapse will not be able to pay all of its bills on time. This makes checking a company’s payment history is an important part of any due diligence process.
There are two good ways to do this; the first is to check their creditor days, this is the average number of days passed the final payment date that they meet their obligations. A company that pays all its bills on time will have a creditor days of zero.
The second method is to see if there are any county court judgements (CCJs) against the company. This is where a debt is so late that the creditor has gone to court to have the demand for payment legally acknowledged and is a key step on the road to the courts forcing the closure of that company. CCJs are seen by many experts as the best indicator of a company being in financial trouble.
A high number of creditor days and any recent CCJs are massive red flags as to a company being a major risk to do business with. Even if they do not go insolvent it is likely they will be severely late in payment.
5. The Company Is In Decline
It may seem obvious but a company that has been reporting decreasing revenue and/or profits year on year is in decline. This may be for a number of reasons, such as, demand for their products or service is reducing, they are consistently not well run or a competitor is taking their business.
Before entering any business relationship make sure that the potential partner is a strong company that will be reliable in the years to come.
How To Perform Enhanced Due Diligence
You would be forgiven for thinking that performing this enhanced due diligence would require specialist staff spending hours searching for this information.
Fortunately, this is not the case as business data has never been more accessible. There are several platforms that will allow you to access everything you need to make an informed business decision.
One such platform is Red Flag Alert.
Red Flag Alert contains up to the minute company reports on over 15 million UK businesses and over 350 million international businesses. These reports contain all the information discussed in this article and more. You can easily see any bad debts or CCJs, all a company’s financial information presented in easy-to-understand visuals and the risk associated with a company va a unique and clear financial health rating system.
Discover how Red Flag Alert’s experienced team can help you mitigate risk and protect your business. Why not get a free trial today and see how Red Flag Alert can help your business?
