Signs of insolvency

In Australia, a company will be insolvent at any point in time that it has insufficient readily available cash to pay its debts, when those debts are due and payable. This can often seem to business owners to happen suddenly and without warning. However, in most cases, there are warning signs that the owners and the directors should recognise so that they can get early advice and then take action to maximise their chance of survival.

1. Summary

There are three main areas that problems can be identified from the statistics gathered by ASIC, that a company is or is likely to become insolvent:

· not enough cash

· poor strategy

· lack of financial control

2. Cash is king

We all know the saying that “cash is king”. In Australia if a company does not have enough readily available cash, it is insolvent. This is the case if the company struggles to pay all of its creditors as required under the agreement and is especially so if it has been happening for more than short period of time. The company is likely to be insolvent unless there is a realistic chance of the company earning enough money in a short period of time to fix that situation.

The signs associated with a lack of sufficient cash include the following:

· dropping sales;

· low balance in bank account;

· forecast cash flow indicating a deficiency;

· consistent trading losses;

· bank overdraft on the limit;

· unable to refinance debt with reputable banks;

· customers leaving the business — going to another provider or closing down;

· the average time for payment by customers blows out;

· unavailability of products from suppliers or significant increase in cost of those products; and

· the owners/directors of the company are not taking a salary or are taking a reduced salary.

The indicators referred to above individually may not mean that the company is insolvent. But, if there are a number of these factors, or any one of them occurs over a long period of time, that is a sign that the company is more likely than not to be insolvent.

If you constantly need to lend money to your company so that it has funds available to keep trading, this can be a sign that financial problems exist. Owners will need to put in funds from time-to-time to prop up the business to meet unexpected circumstances (there is no more obvious example than the effects of COVID-19). If that is the case, owners must protect the investment of those funds as a secured loan registered on the PPSR. Go to www.krodok.com.au to learn more about this protection and how to put it into place quickly, efficiently and inexpensively.

Whilst cash is king and the most obvious indicator of solvency, if a business has more current liabilities than assets on the balance sheet, it is likely to be a warning sign of insolvency. This should be more seriously considered in the situation that there is a forecast of future trading losses.

3. Fail to plan, plan to fail

It is vitally important for a company to have a vision as to where it is going and how it is going to get there. Without a clearly defined strategy in place, businesses run the risk of collapsing because they waste precious funds and don’t pay debts.

Indicators of a lack of strategic planning include:

· insufficient funds to pay employee leave entitlements, especially superannuation;

· key staff members leaving the business;

· supplier changing terms of trade to cash-on-delivery or stopping deliveries until outstanding debts are paid;

· payment plans with creditors, including the ATO;

· only paying creditors part of unpaid debt; or

· receiving statutory demands.

If creditors are constantly following you up for outstanding payments or, sending letters of demand (or a statutory demand), it is a strong indicator that you are facing financial difficulty and should seek urgent advice.

You can seek to enter into a plan with your creditors to pay your debts over time. Payment plans can buy you more time; but, if you fail to comply with the payments under that plan, there is a significant a possibility that your business is already insolvent, which will leave directors exposed to personal liability for the company trading whilst it is insolvent.

4. Lack of financial control

If any of the issues referred to below, applies to your company they need to be rectified as soon as possible. Left unchecked, they can lead to the company failing.

· Not keeping adequate books and records.

· Delay in payment of wages.

· Service of a Director Penalty Notice from ATO (DPN).

· Suppliers moving to cash-on-delivery or collecting stock that they have already supplied because of non-payment.

· Service of a notice of eviction.

· Service of a statutory demand.

The lack of books and records is not only a breach of directors’ duties, it is also a presumption of insolvency. If your business records are a mess, including if you aren’t able to prepare accurate financial statements, you should talk to your accountant about getting things in order. However, if any of the other warning signs in referred to above also apply to you, you should not ignore them and seek timely advice, particularly if you receive a DPN.

While it’s important to pay all of your debts, it’s essential that you pay superannuation and PAYG Tax. The ATO may serve you with a DPN if you do not meet this obligation, which could make you personally liable for those debts.

5. Relationship with the bank

Your bank is constantly monitoring your business’s ability to repay its loan. If you notice a poor or deteriorating relationship with your bank, that could suggest that your business in insolvent. This is on the basis that the bank may see, through its own analysis of the operation and profitability of your business, the early warning signs of financial problems before an owner does. If you notice the deterioration of the relationship with your bank, it could be the right time to seek advice.

6. What steps can be taken

If one or more of the issues referred to above are identified, you need to take stock of the viability of the business. You need to work out whether the business can survive and continue by taking steps such as:

· refinancing the existing debt;

· raising new debt;

· raising new equity;

· trading the business on a reduced basis; or

· only trading the profitable parts of the business and cutting the rest.

If owners recognise the signs referred to above, they should seek advice. The earlier that businesses obtain advice, the more options they have and the greater their chance of survival to thrive again. If small businesses are properly structured at the start of their existence, it will greatly enhance the business’s and the owners’ chance of survival.