Surviving troubled waters

When the global economy goes through a stormy patch, as at present, people are desperate for forecasts on whether businesses they trade with or depend on for business or employment will make it to dry land. Here, we look at the signs which warn that a company or business is in trouble... Whether a business is set up as a company or otherwise, and regardless of prevailing economic conditions, it is the responsibility of those who control the business to ensure that they exercise proper controls over its finances. No one expects a sole trader or the directors of a small trading company to be experts on financial matters. But there is much that business people can and should do for themselves to ensure that they are prepared for financial turbulence and can take effective action to withstand it. Simply being able to recognise problems when they arise is an obvious but crucial first step in riding the storm.

Examples of the sort of warning signs that businesses should be aware of are as follows:

Inadequate credit control

Credit control is all about making sure that a business keeps a tight check on the credit facilities it allows to its customers and clients.
This should involve running credit checks either on all new customers or on those who request credit of a level which exceeds a certain amount which is considered material to the business. The business should also make sure that invoices are issued promptly, that payment terms are made clear to customers at the outset, and also that it keeps a careful check on whether individual bills are paid on time.  Some countries such as the UK go one step further to have legislation which guarantees sellers a statutory right to interest where the bills due to them are not paid on time.  This would serve many small firms well in the Caribbean as they are particularly leveraged by cash shortfalls, especially when their competitors with deeper pockets offer longer-term credit. 

Indications of impending material bad debts
A single bad debt can kill a business.  At particular risk are smaller businesses which are over-reliant for their turnover on a single client or customer. Often, such businesses go to great lengths to cultivate their relationship with the favoured client by affording special payment terms to them. Businesses should keep alert for any information that their ‘favoured’ customer may not be in the best of financial health; they should also consider the long-term sense of remaining dependent on a single client.

Evidence that the business is ‘overtrading’
This can happen when a business grows too fast for its own good. If a product line takes off quicker than expected, then the firm might end up with contractual commitments that are beyond its capital base to honour. A business should ensure that its capital base is sufficient to allow it to produce and deliver the products that it seeks to sell to its customers.  

The presence of a high level of contingent liabilities
A contingent liability is a financial obligation which a business might have to meet should specified circumstances apply and trigger the obligation. If a business has a number of potential liabilities of this kind hanging over it, then should the worst happen and all of them fail to be met, its finances could be overwhelmed. Some firms, because of the line of business they are in, may not be able to avoid accumulating contingent liabilities. If they are inevitable, then they should not be ignored: prudence dictates that the business should make reasonable provision for meeting the consequent debts. 

A history of ‘qualified’ audit reports
Where a business has its accounts audited, the ideal is for the auditor to give the accounts a ‘clean’ report, which indicates that the accounts are ‘true and fair’ and comply with legal rules and professional standards. If the auditor is not satisfied that the accounts meet this test, then he will ‘qualify’ his audit report. This gives a clear signal that the financial statements cannot be relied upon for the purposes of assessing the business’ current or future financial health. This poses a problem in the Caribbean as most small businesses or even large family businesses do not and will not share these true and fair accounts with the public, including those with whom it does business.  

Evidence that assumptions and forecasts used in the past have proved unreliable
Financial management is not an exact     science. Subjective judgments will always fail to be made in relation to, e.g., the profitability of individual investment projects and the likelihood of bad debts arising. All business people hope that the assumptions and forecasts that they make will prove correct. In the real world, of course, this cannot always be the case, but regular checks should be made in this area to ensure that assumptions and forecasts which have proved incorrect are reviewed with a view to making necessary changes.