The downfall of businesses rarely happens by accident. A business drifts rather than falls into collapse. Business failure can happen to a business of any size. It is often the ability to detect the early warning signs that can make all the difference.
Business’s operating within a franchise environment are entrusted with the brand of the business, perhaps the most significant asset of the Franchisor. In order to protect your brand name it is important to be aware of some common signs that your franchisee may be experiencing financial distress.
Implementing a reporting program that incorporates a requirement for a franchisee to provide evidence of its current trading position and compliance with statutory and regulatory obligations is a means of protecting the franchise brand and ongoing viability of the franchisee business.
Alternatively, a right of inspection of books and records of the franchisee provides an opportunity to review on site the franchisee’s business.
Detailed below are 10 indicators of business distress that franchisors should be aware of when reviewing a franchisee’s business performance.
Cash flow difficulties waste considerable resources that do not add value to a business. Cash flow problems may be a sign of poor planning and management of the business by its owners or a sign that the company is insolvent.
Bad management is the major reason for business failure. This can take many forms, including:
- Undercapitalisation from the commencement of the business;
- Insufficient or non-existent planning;
- Inexperienced management team; and
- Lack of appropriate controls
When a business is struggling, regardless of the industry within which it trades, a common element is the non payment of statutory taxation e.g. BAS, PAYG
Failure to pay outstanding taxation is not immediately evident to parties that deal with a company and it may take time for the ATO to take action for recovery of the debt, which provides an opportunity for directors to effectively cash flow their business via the ATO.
What most directors may not realise is that the Corporations Act deems the non payment of taxation obligations a presumption of insolvency which has the effect of placing directors in a position of having to prove that the company is in fact solvent.
The ATO has powerful debt recovery options available to recover ballooning tax debts which can have a devastating effect upon business viability, directors and financier’s security.
An inspection program, incorporating a review of the franchisee’s Running Balance Account (if possible) will facilitate early detection of a franchisee that may be struggling to meet its statutory commitments.
Often an entity that is struggling to meet its present obligations will postpone remittance of superannuation contributions. Again, an inspection program or reporting regime implemented with the franchisee may assist in identifying non compliance in this regard.
If the business overdraft is regularly exceeded or stuck on its limit, this may indicate that the entity is struggling to generate sufficient cash flow from its operations to meet its current obligations.
A review of the entity’s bank overdraft patterns will provide insight into the company’s reliance on overdraft funds and its ability to repay overdraft funds from trading revenue.
Furthermore, a business that operates at its maximum overdraft may struggle to cope with an emergency such as plant breakdown which requires replacement and cash outlay.
A review of supplier invoices may reveal evidence of stop credit and or COD terms where credit terms are the normal practice of the supplier.
A deteriorating relationship with suppliers is a warning sign that the business may struggle to continue to operate profitably.
Are the franchisee’s creditors ageing beyond industry standards? A review of the trade creditors’ ledger will usually indicate whether the business is struggling to meet its present obligations as and when they fall due.
It is important to remember that industry standards vary and it may in fact be the industry “norm” to pay within 60 days of invoice. However, a ledger which reveals a large proportion of creditors outstanding for 90+ days should raise concerns about the company’s cash flow and ability to service its creditors’ ledger.
Another red flag that should raise an eyebrow when reviewing the company’s creditors’ ledger is the existence of round dollar payments made to creditors as well as a regular repayment to suppliers, as this may indicate the business has had to negotiate payments with suppliers in order to continue trading.
A business that is struggling to meet its present obligations will often have regular dishonour fees on its bank statements as a result of issuing cheques to suppliers due to pressure being exerted for payment. This indicates the business may not have the financial resources to honour its payment. It may be a means of ‘buying some time’ from the pressure being brought to bear upon the struggling entity.
Another indication of pending insolvency is the practice of issuing post dated cheques.
The relationship a business has with its bank provides another red flag warning of impending financial crises. A poor relationship and/or inability to secure further finance may indicate early signs of insolvency.
In particular, consider whether the business has implemented budgetary controls and costing systems. Is there a cash flow projection available for inspection and testing?
One of the first functions to suffer when a business is experiencing financial difficulty is its paperwork. Business owners are too focussed on how they are going to pay their bills, and accordingly financial record keeping and planning are forgotten.
An early warning sign that a business is experiencing financial difficulty may be detected in low staff morale. The business may be losing its best people to competitors, creating high staff turnover or low employee productivity. When this occurs, the business faces the significant cost of recruitment and training inexperienced staff.
A physical inspection or attendance at the business premise may reveal insight into the business’s current position.
Often a business that is struggling to survive will show physical signs of deterioration. An inspection of the premises may also reveal insight into the demeanour of staff and management.
Lawler Partners Business Recovery and Insolvency team can provide you with a business health checklist to assist you in designing a reporting program to capture these and other early signs of insolvency. For further information please contact Associate, Rowena Sigelski, on (02) 4962 2294 or email rsigelski@lawlerpartners.com.au.
