Being able to recognise when financial troubles may lead to insolvency is crucial in taking appropriate action to address the situation. But how do you distinguish between financial troubles and imminent insolvency? This article will help you spot some of the key warning signs of insolvency.
What is insolvency?
Insolvency refers to a financial state in which an individual or organisation is unable to repay their debts as and when they fall due.
Warning signs of insolvency.
There are various reasons why an individual or organisation may become insolvent. Being able to recognise the warning signs of insolvency early provides the best chance of survival, through turnaround and restructuring measures, to avoid bankruptcy and liquidation.
Some key warning signs of insolvency are:
- Cash flow crisis. Difficulty in generating enough cash to cover operational expenses, repay debts, or invest in growth is a significant warning sign. If an individual or organisation consistently struggles to meet day-to-day financial obligations, it may suggest insolvency.
- Market changes. External factors, outside of an individuals or organisations control, may have the ability to impact upon one’s financial position. Fluctuating market conditions may heighten the risk of insolvency, particularly those operating in a more volatile industry.
- Increased levels of debt. A rapid increase in debt, particularly when accompanied by an inability to keep up with debt payments, can be an early sign of financial distress. If debt is continually pilling up without a feasible plan for repayment it could easily lead to insolvency.
- Poor performance. A consistent decline in profitability, decreasing profit margins, or persistent losses can erode financial stability.
- Overdue payments and defaulting. Consistently missing payment deadlines and defaulting on loans are clear indicators of financial trouble.
- Legal acton. Legal action from creditors is a significant red flag implying a severe financial situation.
- ‘Growing Broke’. Excessively rapid growth may lead to insolvency. This is where profits fail to keep up with swiftly increasing expansion.
- Liquidity problems. Difficulty in converting assets into cash quickly may signal insolvency. Where there is a lack of readily available funds to meet immediate financial obligations, it can exacerbate the financial strain.
- Inability to secure credit or loans. If an individual or organisation is repeatedly rejected when applying for new credit or loans, it could suggest that lenders perceive a high risk of insolvency. Financial institutions closely evaluate creditworthiness and being denied credit can be a sign of financial instability.
- Strained relationships. If suppliers demand upfront payment, change credit terms, or refuse to extend credit due to concerns about financial stability, it can be an indication of impending insolvency.
- Legal and regulatory changes. Like market conditions, external factors such as legal and regulatory issues can have sever financial implications for an individual or organisation. It can be difficult to keep pace with new legislation or regulatory obligations, and non-compliance with such obligations can have devastating effects which can in turn lead to financial difficulties if not addressed early.
How can I reduce the risk of insolvency?
It is important to note that experiencing one or two warning signs doesn’t necessarily mean insolvency is imminent, but it should serve as a prompt to closely evaluate financial circumstances and take appropriate action.
Seeking professional advice from experts, such as an insolvency practitioner or lawyer, can provide valuable guidance and potential solutions to address financial troubles effectively. If you need advice, contact Hunt & Hunt’s insolvency lawyers on (02) 9391 3000.
Article by Matt Gauci, Partner, Jessica Egger, Senior Associate and Dallas Torresan, Paralegal
