When the Company Is in Trouble: Early Warning Signs for Directors
Companies rarely fail overnight.
The signs usually appear months before. A forecast that keeps slipping. Suppliers being paid later and later. A board pack that arrives a day before the meeting with the cash numbers on page 40. Management saying “next quarter will be better” for the fourth quarter in a row.
Directors who come from finance often see these signs first. You know what a stretched balance sheet looks like. You can tell when a forecast is built on hope. That gives you a real advantage, and a real responsibility.
When a company is in trouble, acting early protects the business, its employees and creditors, and you. Acting late narrows the options for everyone.
This article covers warning signs in the numbers and in the boardroom, questions to ask management, getting advice early, your duties in general terms and the choice between resigning and staying. It is general information only, not legal advice. The laws differ between Australia and New Zealand, so get legal advice early if you have concerns.
Warning signs in the numbers
Look for patterns, not one bad month.
Cash forecasts that keep changing. If the 13-week cash flow is revised down every time you see it, the problem is bigger than the forecast admits.
Creditors stretching. Creditor days rising, suppliers asking for payment upfront or overdue amounts to tax authorities.
Covenant pressure. Headroom shrinking, waivers requested or lenders asking for more frequent reporting.
Losses funded by debt. Borrowing to cover operating losses rather than investment.
Working capital games. Stock building up, debtors ageing, or large payments pushed into the next period to make the month look better.
Profit without cash. Reported profit that does not turn into cash over time.
Going concern questions. The auditor raising doubts, or management resisting the conversation.
Unpaid employee entitlements. Late super or KiwiSaver contributions, or payroll paid late.
Any one of these can have a simple explanation. Several together deserve serious questions.
Warning signs in the boardroom
Some signs are about behaviour, not numbers.
Papers arrive late or change at the last minute. Especially financial papers.
Management becomes defensive. Questions about cash are answered with optimism rather than data.
Key people leave. A CFO, financial controller or head of credit resigning suddenly is worth noticing.
The board stops asking. Directors defer to a strong CEO or chair and stop testing forecasts.
Meetings focus on growth plans while cash runs down. The strategy discussion becomes a way to avoid the hard one.
Information goes to some directors and not others. A split board is a weak board in a crisis.
As a director, you are entitled to information you need to do your job. If you are not getting it, ask formally.
Questions to ask management
Keep your questions specific and ask for evidence.
What is our cash position today, and what is the weekly forecast for the next 13 weeks?
What assumptions sit behind the forecast, and what happens if the main one is wrong?
Are we paying all creditors, including tax and employee entitlements, on time?
What headroom do we have under our banking covenants?
Have we had any conversations with lenders about waivers or changes?
What options do we have if cash falls short: new capital, asset sales, cost cuts or refinancing?
Has the auditor raised any concern about going concern?
Who is advising the company, and when did we last speak to them?
Ask for the answers in writing and make sure the questions and responses are minuted. If the answers do not hold up, say so.
Getting advice early
The most common regret among directors of failed companies is waiting too long.
Get advice early when:
The cash forecast shows a shortfall you cannot see a way to close
Lenders are signalling concern
Statutory payments, such as tax or employee entitlements, are falling behind
You are unsure whether the company can pay its debts as they fall due
Advice usually comes from two places. A lawyer with insolvency and restructuring experience can explain your duties and options. A qualified restructuring or insolvency adviser can review the financial position and options for the business. The board may engage advisers for the company, and individual directors may also want their own legal advice.
Early advice often opens options that disappear later, such as an informal restructure, a refinancing or a sale. In Australia there are also protections for directors who are actively pursuing a plan that is likely to lead to a better outcome than an immediate formal process, but they come with conditions. A lawyer can explain whether and how they apply.
Your duties in general terms
Directors in both countries have duties of care, good faith and acting in the interests of the company. When a company is in financial trouble, the interests of creditors become much more important.
In Australia, directors have a duty to prevent the company trading while insolvent. In general terms, that means not allowing the company to take on new debts when there are reasonable grounds to suspect it cannot pay its debts as they fall due. Directors can be personally liable if they breach it.
In New Zealand, the focus is on reckless trading and on not agreeing to obligations the company will not be able to meet. In general terms, directors must not allow the business to be carried on in a way likely to create a substantial risk of serious loss to creditors.
The tests, defences and penalties differ between the two countries and depend on the facts. That is why legal advice matters so much here.
For more on bringing finance skills into the boardroom, see moving from CFO to board director.
How search consultants see it
When I worked in executive search, board candidates were sometimes asked about their time on a board that had gone through financial trouble. Chairs were not looking for directors who had never seen a crisis. They wanted to know how the candidate had behaved.
The candidates who impressed them could explain what signs they had noticed, what questions they had asked, when they pushed for advice and what they learned. Those who said they had relied on management, or that the problem came out of nowhere, made chairs uneasy. A director who acted early and kept good records is often a stronger candidate after a hard experience, not a weaker one.
Resigning vs staying
When things get difficult, some directors think about resigning. It is an understandable reaction, but it is not always the right one.
Reasons resigning may not protect you. Duties generally relate to your conduct while you were a director. Resigning does not erase what happened before you left. And leaving a board in trouble can weaken it at the moment it most needs experienced voices.
Reasons to stay. You may be able to help steer the company to a better outcome. Your finance skills may be exactly what the board needs.
When resigning may be right. If the board refuses to get advice, ignores clear warning signs, or you cannot get the information you need to do your job, staying may not be possible. Get legal advice before you resign, put your concerns in writing and make sure your reasons are recorded.
Either way, make sure you have your deed of access, insurance and indemnity in place. See leaving a board well.
A quick self-check
Do you see a weekly cash forecast for every board you sit on?
Do you know the covenant headroom?
Are your questions about cash being minuted?
Do you know which adviser you would call if you had concerns tomorrow?
Your next step
Before your next board meeting, ask for the 13-week cash forecast and the covenant headroom if you do not already receive them. If anything worries you, raise it formally and speak to a lawyer this week.
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