In the current economic climate, it is not unusual for businesses to experience cash flow pressure. However, as a business owner or manager you must ensure that you have adequate working capital to avoid liquidation or bankruptcy.
There are warning signs that every business owner should be looking out for to ensure that issues are dealt with quickly, and in a cost effective manner.
For instance, ask yourself the following questions:
- Are you paying creditors outside their normal Terms of Trade?
- Have you received final demands for payment from creditors?
- Have you been placed on 'cash on delivery' terms with essential creditors?
- Are you lodging any of your Business Activity Statements significantly later than due?
- Are total liabilities in excess of current assets?
If you answered yes to any, or all, of these questions, it may be time to review the financial position of your business... Early action is critical to ensuring that a business has the best chance of survival. Sticking your head in the sand is never a good approach!
What is Insolvency?
The insolvency test for businesses is a cash flow test. That is, solvency is assessed by comparing the available current assets to the extent of liabilities that are due and payable.
Current available assets are those assets that can readily be converted into cash, such as stock or debtors.
Current liabilities are those amounts that are currently due and payable.
It is necessary, however, to look at the business in its entirety when determining if it is insolvent as there are many factors that must be taken into account.
The Warning Signs
Being aware of the warning signs helps business owners tackle any issues, seek appropriate professional advice, and minimise the impact to the business.
Some of the warning signs that your business may need help include:
- An increased overall level of worry about the financial circumstances of the business.
- Deteriorating relationship with your bank.
- An occasional inability to meet debtors within the trading terms.
- Inability to pay superannuation on time.
- An inability to prepare timely and accurate financial information, and a lack of records generally.
- An inability to obtain finance from alternate financiers.
- Legal demands for payments from creditors.
- Commencement of Court action to recover amounts owned by the business.
- Repossession of business assets by secured creditors.
Above are only a few examples of the escalating warning signs that a business may be getting into trouble.
What happens if your business is insolvent?
There are several options available to companies that are found to be insolvent, including:
- Liquidation - Liquidation is often referred to as 'Winding Up' and involves realising all of the assets (including property) to cover debts. A 'Liquidator' is appointed who determines the value of the assets and sells them. The company will then be deregistered and will cease to exist.
- Voluntary Administration - Administration is a form of insolvent administration by which either the company's directors or, sometimes, a secured creditor, appoints a Voluntary Administrator who takes control of the company, investigates its history and financial affairs, and makes a recommendation to creditors about how they should vote in respect of the company's future. Creditors may decide one of three things, that is:
- either to return the company to its directors (although in practice this rarely happens);
- place the company into liquidation or;
- enter into a Deed of Company Arrangement, to allow the company to continue trading subject to the terms of the Deed. The benefits of a Deed are that the company may continue to trade and the creditors usually receive more than they would receive if the company were to be placed into liquidation
- Receivership - The term "receiver" usually applies to the appointment of a controller appointed by a secured creditor such as the bank. It also applies to a person appointed by the Court to take control of specific assets for a particular purpose. Broadly speaking, a receiver's responsibilities are usually to a single secured creditor whereas a liquidator's responsibilities are to the general body of unsecured creditors.
What are the consequences of insolvency?
If you are a Director of a company that becomes insolvent, there are some serious consequences to consider:
- You could lose your job if the company is unable to recover and have trouble finding a new job
- You could lose your house and other assets in order to pay the debts
- You might be disqualified as a Director and be unable to gain employment as one in the future
- You could face heavy fines and, depending on the circumstances leading to insolvency and the size of the debts owed, you could even face jail time
- You will personally and financially affect an average of 30-40 people (depending on the size of the company) as a result of your company becoming insolvent and being declared bankrupt
Need more information?
If you are a business owner or company director in NSW who wants to avoid insolvency contact our office to begin putting into place processes and procedures designed to identify the early indicators and protect yourself and your business.