Tips when facing up to insolvency
On Friday the Insolvency Service will release figures showing the number of insolvencies in the UK in the first three months of 2010.
The figures are expected to show a reduction in the number of corporate insolvencies.
The position with personal insolvencies or bankruptcies, which include debt relief orders introduced this time last year, is expected to remain stable or at least show a reduced rate of increase.
Now that the recession is technically at an end, can we assume the worst is over?
Insolvency time lag
A report from business recovery firm Begbies Traynor revealed that the number of businesses experiencing significant financial problems had jumped by 20,074, or 14%, to 161,601 in the first three months of this year.
It is also thought that there are one million individuals who have not yet faced up to their debts, or are struggling on with payments helped by benign interest rates.
And it is estimated that there are a further 500,000 people who are negotiating with their creditors, but who do not form part of the formal insolvency statistics.
Insolvency trade body R3 has warned of an "insolvency time lag".
Figures from the two previous recessions in the 1980s and 1990s show that the peak in both personal and corporate insolvencies occurred after the return to growth.
In the 1990s, the peak in company liquidations was a year and a quarter after the return to growth, and for personal insolvencies it was a year and a half after.
The lag is due to the time it takes before creditors begin to lend at pre-recession levels or before employment and spending pick up.
Company directors should be mindful that the worst may not be over and that they will have to tackle liquidity problems head on, particularly if the credit conditions do not ease over the coming months.
There are four key areas that businesses need to address in order to survive the recovery.
Firstly, directors should avoid focusing on profit and loss as it is not usually lack of profitability that causes businesses to fail - it is lack of cash.
The reason why most businesses fail is that they simply cannot pay their bills; they become cashflow insolvent.
Adequate management systems need to be in place, and directors must act on the warning signs before they become problems.
Secondly, a view should be taken on customers' likelihood to default as such an event can be crippling.
Consider Companies House searches, checking with a credit reference agency, and obtaining credit insurance.
Clear credit limits should be set for every customer, to limit potential losses.
Thirdly, remember, "turnover is vanity and profit is sanity".
New business must be profitable and without significant risks and unfavourable terms for payment.
It can be very tempting to bend over backwards for a shiny new contract with a large corporate client, but they often want longer payment terms so it could be months before you get paid and the margins will be lower.
Finally, spread the risk.
We have dealt with a number of companies who have relied on just a handful of customers, where the failure of just one can wipe out your business.
Businesses should look to actively market products and services and expand their customer base.
Most observers agree that historically low interest rates have allowed some borrowers to keep up repayments on debts which would otherwise have been unmanageable, and that any interest rate rise could push many more people into difficulty.
A person who is unable to meet their financial commitments does not automatically go bankrupt.
Insolvent individuals have three other choices:
- a debt relief order (DRO), whereby a person is discharged from their debts after 12 months
- an informal arrangement with creditors, thought this does not prevent creditors ignoring it later and pursing the debtor for the full amount
- and an individual voluntary arrangement, a formal binding arrangement with creditors that is administered by an insolvency practitioner.
People who feel they cannot make ends meet should firstly prepare an income and expenditure statement and a realistic budget prior to seeking advice.
The introduction of DROs for individuals with less than £15,000 in debt has had a limited impact due to the fact they are restricted to people with less than £300 in assets, including their pension.
In a recent survey by the Citizens Advice Bureau, figures showed that 96% of people were excluded from using a DRO because of their pension.
All too often, people's attitude can be the real barrier to finding a workable solution.
Directors can be overly optimistic about their company's prospects, partly to soothe investors, placate suppliers, bolster colleagues and combat worry in the workforce.
It is also partly because they cannot contemplate failure and therefore put too much faith in the next sale, the next deal, or creditors' patience.
In common with individuals, they tend to put off facing up their debts.
The result is that many companies and individuals delay dealing with their problems until it can be too late to find alternatives and they end up part of the insolvency statistics.
These tendencies are being exacerbated by the return to growth of the economy which is inspiring increased confidence.
One of the most important actions that directors can take in order to ensure that their business gets through the challenging times ahead is to take off their rose-tinted spectacles.
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