Thomas Cook, one of the world’s largest and oldest travel companies, recently went out of business due, at least in part, to unserviceable debt levels. (1) While carrying debt is a standard business practice and a legitimate cash flow management technique, businesses should keep a close eye on how much debt is too much, and should be aware of the warning signs that the business could be in trouble, according to Atradius.
Thomas Cook had debts of J1.7billion, and was waiting on approval of a recapitalisation request. (2) Despite considerable efforts, those requests did not result in agreement between the stakeholders and proposed new money providers, making the board declare compulsory liquidation of the company with immediate effect. (3)
Mark Hoppe, managing director, Oceania, Atradius, said “Debt-laden businesses are more vulnerable to unexpected bumpy conditions and sudden business shocks. It’s very important for businesses to keep a close eye on their debt-to-income (DTI) ratio, which is a measure of the amount of business income being spent on debt each month.
“There are also other factors that can help provide early warning that a company is in trouble. If the business catches those signs early enough, it could be able to avoid or reduce the amount of money owed if the buyer does become insolvent.”
Atradius, a leading trade credit insurer has identified 10 key warning signs that can mean a business is in trouble:
1. Too much debt: like Thomas Cook, if the company has a high DTI ratio that it can’t service, it will likely drown under the weight of its debts.
2. Over-expansion: expanding too quickly or taking on too much debt to expand is risky even if the business owners are highly experienced.
3. Lack of clarity: business owners should be able to clearly articulate how the business generates cash.
4. Qualified accounts or going concern commentary: businesses that are in trouble may have qualified accounts, which are audited accounts where the auditor has doubts about the company’s management. Going concern commentary is less serious but shows the auditor is protecting themselves from litigation while still signing off on the accounts.
5. Profit warnings: a profit warning is the clearest sign that a company won’t meet its earning expectations.
6. Profit versus cashflow: a company showing strong profits but little cashflow may be doing some dishonest accounting.
7. Irregular payments: if the company can’t pay debts and invoices regularly or on time, or even if the company can pay but does so in lump sums after periods of non-payment, then cash flow is likely compromised.
8. Unstable leadership: many changes within a company’s leadership is a sign of trouble.
9. Trappings of success: if directors have expensive cars or furnishings it could mean they’re rewarding themselves at the business’s expense. This isn’t necessarily a sign of trouble but, if any of the other signs are present, it could warrant further investigation.
10. Late filing of accounts: companies that file their accounts late are either disorganised or had trouble getting the auditor to sign off. Either reason is cause for concern.
Mark Hoppe said, “Businesses shouldn’t overreact if they see one or two of these signs but if they see more, or if the circumstances are severe, then it could be a sign that the business really is in trouble. If the business under consideration is a potential customer, three or more of these signs could be a good enough reason to do further due diligence or decline to do business with that organisation.
“If a director is seeing these signs in their own business, they should definitely investigate further and, if necessary, appoint an independent auditor. Recognising the warning signs is just the first step; it’s essential to act on these signs to avoid undue business risk and also look at cash flow management strategies like trade credit insurance to protect the business if a buyer does become insolvent.”