Zombie companies: How to spot the walking debt

A zombie company is generally defined as a business that generates enough income to continue operating, but lacks the profitability needed to reduce its debt or invest in future growth. While it may remain trading for years, it is often financially fragile and more vulnerable to economic shocks than healthier businesses.

Although there is no universally accepted definition, zombie companies are typically characterised by persistent debt burdens, weak profitability and limited growth. Factors such as economic uncertainty, inflationary pressures and higher financing costs have also increased the number of businesses operating under sustained financial strain.

Zombie companies rarely emerge because of a single event. More often, they develop gradually through a combination of weak profitability, challenging market conditions and continued access to funding.

For some businesses, a period of rising costs, declining demand or increased competition can put pressure on profits. If earnings remain weak for an extended period, debt can become harder to manage and investment plans may be delayed or cancelled altogether. Rather than using profits to grow the business, management may find themselves focused on maintaining day-to-day operations and meeting existing financial obligations.

Over time, this can create a cycle where a company generates enough income to survive, but not enough to significantly reduce debt, improve productivity or invest in future growth. While some businesses recover through restructuring or improved trading conditions, others can remain in this financially fragile state for years.

The impact of prolonged access to cheap credit

For much of the period following the global financial crisis, businesses benefited from historically low borrowing costs. This enabled many companies with relatively weak profitability to continue operating despite limited growth prospects.

For much of the period following the global financial crisis, businesses benefited from historically low borrowing costs. The relationship between cheap credit and zombie companies has been studied for decades, particularly in Japan following the asset price crash of the 1990s, where some indebted businesses were able to continue operating despite weak profitability and limited growth prospects.

Government-backed support schemes introduced during COVID-19 also helped businesses weather unprecedented disruption. While these measures were vital for many otherwise viable companies, they also allowed some financially challenged firms to continue operating for longer than they otherwise might have done.

The role of lenders

Lenders may sometimes choose to restructure or extend borrowing arrangements rather than force a business into insolvency. In some cases, this gives a struggling business a genuine opportunity to recover. In others, it simply prolongs the inevitable, allowing a zombie company to stagger on without addressing the underlying problem.

Like their fictional counterparts, zombie companies can appear active from a distance. Look a little closer, however, and these warning signs often start to emerge:

• Rising debt levels and a highly leveraged balance sheet
• Low profitability and limited growth over several years
• Weak cash generation and pressure on working capital
• Reliance on refinancing or additional borrowing to continue operating
• Persistent late payments or requests for revised payment terms
• Limited investment in people, operations or expansion plans

The earlier you spot the warning signs, the easier it is to protect your business from unnecessary credit risk.

Zombie companies may sound like a niche phenomenon, but they're more common than many businesses realise. Recent research from BDO found that 15.9% of UK mid-market businesses were at risk of zombie status, with sectors such as real estate, leisure and hospitality showing particularly high concentrations.

SMEs are often more exposed due to smaller cash reserves, limited financing options and greater sensitivity to economic shocks. For businesses that trade on credit, this underlines the importance of understanding the financial health of customers and suppliers.

There is no official register of zombie companies. Instead, analysts typically apply the label to businesses that show sustained difficulty generating enough earnings to comfortably support their debt obligations.

Financially stressed businesses can be found across every sector of the economy, particularly during periods of economic uncertainty and higher borrowing costs. A company's status can also change quickly through restructuring, refinancing, trading performance or changes in market conditions.

Rather than focusing on individual names, businesses are generally better served by monitoring financial health indicators and changes in trading behaviour.

Not every company facing challenges is destined to become a zombie, but understanding the warning signs can help you identify potential risks before they turn into a cash flow nightmare. To learn more about how one struggling business can create a chain reaction of financial distress, read our article on the domino effect of insolvencies.

A strong credit management approach should include:

• Assessing customer creditworthiness before extending terms
• Monitoring customers regularly, not just at account opening
• Reviewing exposure limits as trading conditions evolve
• Acting quickly when warning signs emerge
• Considering risk transfer solutions such as trade credit insurance

By combining good credit management with tools such as trade credit insurance, businesses can monitor evolving risks, protect against unexpected insolvencies and trade with greater confidence, whatever economic surprises may be lurking around the corner.

Understanding the warning signs of financial distress can help businesses make more informed credit decisions. Trade credit insurance provides ongoing monitoring and protection, helping businesses trade with confidence even in uncertain market conditions.

Speak to our team to learn more about how trade credit insurance can support your business:

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