For someone that works with businesses in financial distress, determining whether a company is insolvent is almost intuitive. However, there are several signs and predictors of insolvency that different stakeholders can recognise.
But first, what is insolvency? Insolvency is a state of being insolvent, whereby a company cannot pay all of its debts, as and when they fall due.
‘Z-score’ empirical sign
Edward Altman developed an empirical evidence technique that uses five financial ratios and a statistical analysis technique known as linear discriminant analysis to predict if a company was solvent or insolvent. The ‘Z-score’ has been found to be 95% accurate one year prior to insolvency and 72% accurate two years prior to insolvency.
Depending on your view of a company, there are some typical signs and symptoms of financial decline. I have sometimes interviewed some of these observers to get a broader picture of the business situation of my clients. For each observer below, I have outlined some (not all) of the typical signs:
1. ‘Man in the street’
At the time of writing, and using Virgin Australia as a case, you will note a few of these signs are clear from the position of the ‘man in the street’.
2. Informed person
4. Suppliers and customers
5. Investigating accountant
So, as you can see, there are many signs of insolvency or impending insolvency. A caveat: just because some of these signs are evident, it does not imply that a company is or will be insolvent. The first task on a new engagement of a turnaround or restructure is the analysis stage, which involves undertaking a diagnostic review with the following objectives
When a company is quickly running out of cash and becoming insolvent, this process needs to be ‘quick and dirty’ and the signs of insolvency are quick indicators of areas that need to be addressed.