Five Signs Your Business is Headed toward Bankruptcy
1. Cash-flow. Cash-flow. Cash-flow.
This is the most important and sensitive indicator of impending problems. The financial security of a business is its positive cash-flow.
But what is the cash-flow? How is it different from a regular budget?
Simply put, cash flow is dollars in and dollars out. A cash flow is sensitive to the timing of income and expenses. It recognizes revenue when received and it recognizes expenses when paid.
By contrast, an income and expense statement typically recognizes revenue when invoiced and recognizes expenses when billed, irrespective of when the account is collected or the bill is paid.
So for example, let’s look at two companies.
Company A forecasts its income for the current year to be $1 million and projects expenses to earn that income at $600,000.
Company B has much more modest projections regarding its earnings. It projects $24,000 of earnings for the year and $12,000 of expenses.
It would seem that company A is likely to be far more profitable and successful.
But company A has a problem. It must meet its monthly expenses of $50,000, but will only receive payment for its services or goods in the 11th month of operation.
Company A has no cash to meet its current obligations. Without an injection of cash, it will go out of business before the work is completed and payment has been received.
Company B receives $2000 a month for its services and can meet its monthly expenses of $1000 with ease.
Company A appeared to be far more profitable, but it is unable to meet its expenses as they fall due. It is a victim of negative cash-flow.
Positive cash-flow is critical to the viability of a business.
A reduction in monthly receipts and / or and increase in monthly outflows will strain the cash-flow of a business.
Reduced revenue can be caused by a number of factors.
Covid-19 has put many so called non-essential businesses into hibernation, with little or no ability to generate revenue. Covid-19 has also resulted in diminished demand for products or services.
And even when services are provided or goods are sold, the purchasers may not have the ability to make payment.
2. Staffing issues
The Government of Ontario declared a state of emergency on March 17, 2020. This meant that non-essential workplaces remain closed and there were restrictions on social gatherings and events. Some companies have been forced to lay-off staff. In other instances, key staff have been forced into extended absences due to Covid-19.
Aside from fall-out from Covid-19, employee dishonesty, theft or confidentiality breaches may not only impact the company’s bottom-line, but may mortally harm its operations.
Businesses that have struggled may have staff and management that exhibit signs of apathy and fatigue. Owners may have given up hope.
The business itself may appear unkempt, disorganized and neglected.
Key employees may display an attitude shift or ‘toxic’ attitude toward their subordinates, co-workers or customers. Businesses exhibiting a loss of unified vision for growth or have lost the of confidence of senior staff may not have impetus to right the ship.
3. Lack of financial stability
Financial stability refers to the ability of a person or company to withstand financial shocks. A company without sufficient resources to deal with financial emergencies is vulnerable to failing.
Companies must look long-term to ensure that there are sufficient resources to handle unforeseeable periodic expenses.
It may also be prudent for a company to ensure that it has sufficient general and professional liability insurance or product liability insurance to safeguard against employee and third-party claims.
A company that has not developed a plan to deal with unforeseen exigencies lacks financial stability and is likely to fall into insolvency.
4. Creditors knocking at the door.
A creditor may take legal action (sue) to recover a debt. The resulting judgment can be used to seize assets of the company. Moreover, the judgment creditor can take steps to recover from the company’s account debtors. This may significantly strain the cash-flow of the company and may negatively impact on goodwill with its customers.
If the creditor holds security over the company assets, it can—upon default of the loan–simply enforce its security (seize and sell) and sue for any shortfall suffered. The seizure of key equipment / machinery by a secured creditor will likely bring a halt to the company operations.
A commercial landlord in Ontario has considerable power to recover outstanding rent payment. If provided in the lease agreement, a landlord can terminate a lease even if rent is one day late! Alternatively, the landlord can commence distress against the property onsite, by seizing and selling the company assets in satisfaction of what is owing.
5. Payroll and HST arrears –the dreaded Deemed Trust
The CRA has stated that the moment when a company cannot remit employee source deductions is when it should cease operating.
Most businesses that face cash-flow issues prioritize based on what is required to keep the landlord at bay, supplies coming in and the lights remaining on. Invariably, payment to CRA in relation to source deductions, HST and / or tax installments is pushed to the back-burner.
The banks and other creditors have upped their vigilance in ensuring that the companies to which they lend remain current with their CRA obligations.
Companies that fall into default making source deduction or HST payment may find themselves in default under the terms of their bank loans. If the property of the company becomes subject to a statutory deemed trust in favour of the CRA for source deductions or HST, the CRA can seize and sell company assets—whether secured or not.
Many lenders require a “comfort letter” from the CRA before providing credit given that a deemed trust in favour of CRA will rank ahead of most security interests.
The CRA may simply seize property or receivables of the company to recover what is due.
Summary: These are the tell-tale signs of trouble for a company. The majority of business owners that consult our office have waited far too long to be able to correct the death-spiral in which they find themselves.
Creating a recovery plan requires vigilance to the above issues and early intervention.
About The Author
Jacques Rusinek
Dr Jacques (Jojo) Rusinek successfully challenged the National Insolvency Exams in 1998 and was licensed as a trustee in bankruptcy (now known as Licensed Insolvency Trustee) in 1999. Prior to becoming a bankruptcy trustee, he practiced in the health care field where he helped people to become pain-free. Now he helps people to become debt-free.
