BACKGROUND
In view of increasing risks that companies may currently face as a result of sharp rises in energy prices and commodity prices, combined with rising interest rates and weakening customer demand, the risk of corporate insolvencies in Germany has increased substantially compared with previous years.
So far, this cannot be witnessed in the historical development of the number of insolvencies. Creditreform reports that “despite the war in Ukraine and the associated impact on the German economy [… ] the number of corporate insolvencies [remains] at a low level for the time being. In H1 2022, 7,300 corporate insolvencies were registered. Compared with the same period last year (H1 2021: 7,510 corporate insolvencies), the number of cases has again fallen slightly.” Nevertheless, Creditreform fears that this will not remain without consequences for insolvency development due to the worsened economic conditions caused by the war in Eastern Europe, the supply-side price increases and the incipient turnaround in interest rates.
In our article, we highlight the possibilities for early detection of insolvency risks of a company and, together with our guest author, Prof. Dr. rer. nat. Alexander Förster, comment on selected options for action that remain for a company in the event of timely detection of insolvency risks in order to safely steer the company through troubled waters.
Thomas Wirtz is a tax consultant, business graduate and owner of schütze & wirtz Steuerberater I Tax Consultants since 2019. Previously, he worked for over 18 years as a management consultant (most recently as a partner / director) with stations in Indonesia, Australia and Indonesia. Thomas Wirtz is particularly interested in tax and financial consulting for companies and individuals, as well as the digitalization of accounting processes.
EARLY DETECTION OF INSOLVENCY RISKS
Companies are confronted with ever-expanding complexity and increasing dynamism in their business environment, and must respond more quickly and effectively to emerging circumstances. In the best case scenario, surviving a crisis means taking timely action to avoid a crisis situation to such an extent that it can no longer have any or hardly any negative impact.
It also follows from the general duty of care that managing directors must continuously monitor the economic situation of their company; this applies in particular in times of crisis. Managing directors who violate their obligations are liable for the damage caused.
A prerequisite for an effective system of early assessment of insolvency is the existence of a risk management system. Its task is to recognize critical warning signals in the company in good time and to counteract them with suitable measures in order to avoid them or at least minimize the risks.
Selected warning signals for a company crisis can be the following, for example:
- Underutilization of personnel
- Low digitalization competence
- Delivery bottlenecks (disrupted supply chains)
- High dependencies on a few suppliers and customers
- Build-up of inventories
- Decline in capacity utilization
- Losses
- Utilized credit lines
- Reduction of limits by trade credit insurers
- Payment stagnation
- Products at the end of the product life cycle
- Declining market share
- Continuous loss of margins
Methods for early detection of insolvency risks include:
- Traditional balance sheet analysis (asset development) – balance sheet analysis looks at the historical development of (key) figures such as the so-called debt to equity ratio, bank balances. The biggest criticism of traditional balance sheet analysis is that it looks at the past and the reporting date. For this reason, other methods should be used for the early detection of insolvency risks, which in particular model the future development of a company.
- Consideration of earnings development (economic development) – consideration of historical and projected earnings development shows whether the company is and will be able to generate sustainable profits. For companies that are not able to generate sufficient profit, the risk of insolvency increases significantly.
- Preparation of a business plan – in our opinion, preparing an integrated business plan and updating it regularly during the year and comparing it with actual business performance is a particularly suitable method of identifying insolvency risks. When preparing a business plan, it is important that it includes a cash flow statement, as well as a balance sheet and profit and loss statement. If possible, so-called scenario or sensitivity analyses should also be used.
- Mathematical-statistical methods – in practice, mathematical-statistical methods ( e.g. multivariate discriminant analysis) are increasingly being used to identify insolvency risks at an early stage.
OPTIONS FOR ACTION
STRUCTURAL MEASURES TO PREVENT INSOLVENCY
Prof. Dr. rer. nat. Alexander Förster has been teaching business informatics in the Department of Economics at Bielefeld University of Applied Sciences since 2017. Previously, he was Head of Corporate Strategy at Wolters Kluwer in Cologne, responsible for Digital Transformation, and a strategy consultant at Droege International Group AG.
If an impending insolvency is recognized in the early stages, the options for action expand significantly. While only drastic measures (see below) are often effective in the case of an insolvency that is recognized late, measures that are more strategic and effective in the long term can still be introduced in the early phase, which tend to have the character of fundamental optimization measures. In the following, we look at three measures in detail:
- The classic among the options for action is personnel restructuring with the aim of reducing personnel costs. A company’s personnel requirements are determined by the activities and business processes to be performed and the skills and competencies required for these. A well-founded restructuring measure should therefore always be preceded by a process analysis. A proven procedure is to first create a matrix of the activities to be performed and then to have the existing employees indicate their individual contribution to the processes in a survey. In the case of larger organizational units, IT-based tools are suitable for this query. Based on the resulting analysis, target capacities for individual processes can be determined and then free capacities for restructuring can be identified. Experienced external consultants typically provide support during the process and capacity analysis in order to maintain a neutral view of the company and the people involved and to optimally control the procedure.
- Another option that also contributes to the company’s success in the long term is to optimize the business processes themselves, especially in light of the opportunities offered by digitization. Many companies have processes that are highly repetitive and could be automated. An example would be a controller who spends a week every month transferring data from one system to another, making the same adjustments and accruals over and over again. Although parts of this may be aware of how inefficient this approach is, and it frustrates the people involved, there is often not the time to accomplish meaningful process optimization through a digital tool. Here, too, consultants with a combination of business and IT know-how can make a valuable contribution: an automated IT tool can be created once and significantly free up personnel capacity for other activities in the long run.
- Finally, it is possible to improve the cost and cash situation in the relatively short term with a purchasing optimization project. Even efficiently operating purchasing departments that have been established over the long term often fail to leverage the full potential savings that are possible in the procurement area. This is often due to entrenched structures and a lack of time and opportunities for comprehensive optimization. The first phase of a purchasing optimization project is always a comprehensive data analysis and the structuring of all procured goods and services into material and product groups. Depending on purchasing volumes, dependency ratios and other parameters, individual purchasing strategies are developed for each material or product group. Possible strategies are, for example, volume bundling, framework agreements, joint growth, effort reduction, etc. Based on the material group strategy, all important supplier relationships are then renegotiated. Typical savings potentials are >10% when such a project is fully executed.
SELECTED SHORT-TERM Tax AND FINANCIAL Measures
In practice, impending insolvencies are often recognized late. Therefore, short-term tax and financial options for action are then more likely to be required, and are listed below as examples:
- Reduction of advance tax payments
- Deferral of tax payments (exception: sales tax is generally not deferred by the tax office)
- Tax optimization of the tax balance sheet (e.g. special depreciation)
- Extended payment terms with suppliers, debt forgiveness, deferral of payments
- Capital increase, (state) guarantees
- Sell-and-lease-back
- Introduction of factoring
In case of impending insolvency and/or equity over-indebtedness, it is strongly advisable to contact a specialist lawyer for insolvency law in good time in order to identify and address legal risks (e.g. insolvency delay, liability risks, etc.).
HOW CAN WE SUPPORT YOU?
Together with its partner, Förster Digital Business GmbH, schütze & wirtz supports digital transformation, process optimization and cost reduction measures from a holistic perspective that brings together commercial and IT aspects and creates customized solutions. Our services include, among others:
- Purchasing and supplier optimization
- Optimization of working capital, capital structure and fixed and financial assets
- Tax optimization
- Negotiations with banks and/or equity providers
Please do not hesitate to contact us.
Sources: creditreform.de
Photos: Gerd Altmann (Pixabay) and private
Disclaimer: We assume no liability for the accuracy and completeness of the information. The information provided here does not constitute a recommendation for action.