How Early Financial Warning Signs Can Protect Your Business from Crisis

In many business failures, a collapse can look sudden from the outside. The underlying problems usually begin months or even years earlier and businesses that avoid crisis are those that spot financial instability early and act on it quickly.

Here, we look at some of the financial stability measures and early warning signs you need to know about for your business.

Cash flow: a key stability measure

A key reason for business failure is running out of cash, not lack of profitability.

“Lock-up”, which is the time between starting work or buying stock and invoicing and receiving payment, is a critical measure for any business holding stock or dealing with work-in-progress (WIP) and credit terms.

If lock-up is high or increasing, the business will eat into cash reserves or become more reliant on overdrafts. This weakens its ability to cope with unexpected shocks.

When stock, WIP or debtor days are rising, it does not automatically mean something is wrong, but it might indicate that:

• Projects are not being managed effectively.
• Billing is too slow.
• Demand has dropped, or the business is holding more stock than it needs.
• Credit control is too weak.
• Potential bad debts are accumulating.

Of course, the earlier these issues can be addressed, the better.

Borrowing and debt levels

While borrowing to grow the business is normal, borrowing to survive usually points to deeper issues.

If the business is borrowing without any linked investment, using new borrowing to pay off old borrowing, or if you are regularly putting in personal funds to cover day-to-day costs, it is a sign that more cash is leaving the business than it can generate.

The key is to understand why the cash is being used up. It might be slow customer payments, unprofitable work, rising overheads or something else.

Once you identify the cause, you can take targeted action. That might be to tighten credit control, review how work is priced, or cut back on the parts of the business that are costing more than they bring in.

People cost and gross margin

In any business, having too many senior people and not enough productive employees erodes profit. On the other hand, having too few experienced leaders can lead to a lack of control and poor decision-making.

One way to assess whether this may be affecting your business is to compare your total people costs against turnover.

The ideal percentage will vary from business to business; however, higher figures could suggest that:

• There are inefficiencies in how things are being done.
• Work is being under-priced.
• There is too much spare capacity.
• The staffing mix is imbalanced.

Gross margin is equally important. Regularly monitoring this by department, team or area of the business will reveal underperforming areas long before they show up.

Overheads as a percentage of income

It can be useful to benchmark overheads as a percentage of income and then monitor these percentages.

Over time, you will be able to establish patterns of what is normal for your business  allowing you to more easily spot where costs are ramping up. While the specific percentages will vary by businesses, the principle is universal: if overheads grow faster than turnover, margins shrink and the resilience of your business weakens.

Non-financial warning signs

Financial instability rarely appears on its own. You might notice other red flags, including:

• Staff turnover increasing.
• A rise in complaints or service failures.
• Changes in sales patterns.
• Key suppliers tightening their credit terms.

If you would like help setting up Key Performance Indicators (KPIs) or interpreting their trends, benchmarking your results against similar businesses, or identifying potential issues, please do get in touch. We would be happy to help you understand what the numbers mean and work with you to make clear, practical changes that keep your business on a stable footing.