What to ask to check your contractor limited company’s viability

There’s a lot of questions contractors should ask themselves to gauge the financial health and viability of their limited company – and I am seeing a real mix of businesses in distress – but there’s probably three in particular that are fundamental, writes licensed insolvency practitioner Gareth Wilcox, partner at Opus Business Advisory Group.

If my current outlook for businesses in the coming year is anything to go by, this trio (which I will come to) is about to experience a resurgence. And it’s not just my outlook which indicates that this looking in the mirror to enquire with yourself about the fundamentals of a business is going to get more popular.

Grim reading courtesy of The Insolvency Service

The latest insolvency statistics (to December 2022) make for fairly grim reading. While the rise year-on-year is a relatively modest 32%, the number of registered company insolvencies compared to December 2019 (crucially, pre-pandemic), was 76% higher. 

This is an important comparative, since it reflects the effects of the coronavirus pandemic itself, and in some cases, the effects of covid support packages, both in the cold light of a turbulent post-pandemic world.

The stats show that overwhelmingly the most common insolvency process is a Creditors Voluntary Liquidation, with administrations being 20% down on December 2019. Since administration is ordinarily (although not always) a process in which an underlying business is attempted to be saved, this suggests there may be less confidence in business turnaround prospects than there has been historically. That’s probably understandable given the sheer number of different and challenging issues in the economy right now.

What do the latest insolvency statistics not show us?

This particular update from The Insolvency Service does not show us the relative sizes of the business failures, or whether any sectors are suffering disproportionately. 

From my perspective, I have been approached for advice recently from businesses operating in a variety of different sectors, including manufacturing, retail, wholesale and professional services. The businesses seeking advice have also been various in terms of size, ranging from small one-man/woman-bands, right up to bigger SMEs with larger workforces and cost bases.

While the industries and sizes of business have varied, a common theme has generally existed among them, which is that it is getting more and more expensive to operate an enterprise in the UK. 

This is clearly attributable to several factors impacting the economy, particularly rising energy prices and borrowing costs, but also increases to staff costs either due to the rising minimum wage, or difficulties in attracting and retaining talent.

The first of three key questions to check your PSC is viable

The first piece of advice I’d give any business-owner may seem obvious, but in a world where wages, utilities, material costs and interest rates are all increasing, it’s a question that is getting lost:

‘Am I still making money’? 

Tragically, the number of business-owners that are not regularly asking themselves this simple but fundamental question appears to be far too high.

Clearly, if the answer to the question is ‘no,’ it is imperative that a director establishes what (if anything) can be done to change this. It is important to be realistic, and often worth modelling a few differing scenarios from best to worst case. A well-organised and properly formatted spreadsheet is often your friend here. 

While it is not always possible to pass additional costs onto clients in full, an open dialogue with customers, particularly in the current economic climate, can reap rewards. Speaking frankly with clientele can be the difference between a business surviving and failing.

Prickly bits are preferable to…

Negotiations will always have a degree of commercial (and often personal) sensitivity, but those prickly bits are generally preferable to a client compared to the prospect of a sudden, unannounced termination of supply.

Having established whether a business is making money in general, the second question (which is particularly important for contractors and owner-managed businesses) is to ask whether the business is sustainable. 

This is often best-established by asking:

‘Is the business making enough money?’

Most people go into business partly because they believe it can support their lifestyle. But don’t go to extremes to prove or hang onto that belief. In fact, the instance of business-owners working unsustainable hours and suffering personally, only to still find themselves worse off than they would have been had they been employed by someone else, is remarkably regular in my experience.

By doing and documenting the above, a business-owner is effectively protecting themselves on two fronts.

First, if issues are identified and overcome, a business failure is less likely. Second, should the worst happen and a liquidator be appointed, a director who has documented a rationale for continued trading is far better protected from claims being brought against them (by the liquidator or The Insolvency Service) than one who has nothing to offer in writing in this regard.

What else should I be checking if I’m a director with financial concerns?

As well as whether a business is making money going forward, it is important for directors to take regular stock of where the business is now.

This can be as simple as looking at a balance sheet showing what assets the company has compared to its liabilities. It is important that any covid-support borrowing is included in this calculation. Remember, any government-backed guarantee is provided to the lender, and only takes effect once a business has failed -- you cannot rely on it yourself, personally.

It is not a foregone conclusion that a company which is insolvent (i.e. liabilities exceed assets) should cease and/or be placed into liquidation. But in order to protect themselves from allegations of ‘wrongful trading’ (and therefore personal liability for debts), a director must have a reasonable expectation that the position is going to improve. Again, take care to document your reviews regularly, and stress-test them against potential scenarios. 

The other key point to a solvency calculation is ensuring that directors are not caught in the ‘dividend trap’ where they find themselves with insufficient profit reserves to be able to declare dividends and repay drawings. This is a situation that was common back in the first and second quarters of 2021 and it still traps directors very regularly in 2023. The kicker is that once trapped, directors will find themselves seriously limited in terms of the options and support which can be provided to them when facing an insolvency process.

The third key question to ask of your business

In conjunction with the above, it is also important for a director to ensure they are carrying out ‘self-help’ for their businesses and identifying potential risks. The latter typically includes ‘overexposure’ to a client, either in terms of a percentage of revenue they represent, or a failure in ensuring adequate credit control in allowing a debt due from a client to increase over time. 

And here we come to the third and final fundamental question.

Ask yourself:

‘What if this client itself stopped trading -- tomorrow?’

Not considered enough is the impact in relation to lost debt and future revenue. As the statistics show, this is not necessarily as far from reality as directors like to think.  Remember, the ‘debtor’ asset on your balance sheet review is only as good as the party who is due to pay-up.

Final thoughts

Unfortunately, the likelihood that 2023 is going to bring a significant increase in business failures is at least fair. Whether these have a root cause in increased trading costs, HMRC running out of patience with struggling taxpayers, or unviable businesses that have only been able to make it through the last three years with Covid-support but are now flailing, the amount of debt in the economy is staggering. 

According to the Bank of England, aggregate corporate debt increased by £79 billion to £1.4 trillion between end-2019 and 2021 Q1, partly as a result of covid-borrowing. We are starting to see the impact of this now, with an increasing number of businesses finding that they cannot afford to repay the sums they owe, and unable to refinance due to decreased lender appetite and higher borrowing costs.

As such, business-owners should do all they can to stop themselves being part of a ‘domino effect’. Hopefully the three questions recommended here can see a few less tumbles. Very finally, if those questions don’t return the answers you want, remember it is imperative for any directors who think their company is in an insolvent or worsening position to take advice at the earliest opportunity.