Understanding the early warning signs of insolvency

David Hodgson 21 Apr 2020

With the world in the grips of COVID-19 and facing tough knock-on effects to all parts of the economy, the Australian Government has released multiple massive support packages to provide relief to individuals and business owners.

Even with this welcome support, some companies are still struggling. Heading towards the zone of insolvency — or facing the inability to pay debts as and when they are due — can be caused by many different factors, some not within a business owner’s control.

One of the relief measures introduced provides businesses with some breathing space: a six-month blanket moratorium for directors with respect to insolvent trading liability. Notwithstanding, it is still important to understand the early indicators of insolvency so you have more options and opportunity to right your business’s trajectory without the need of a formal insolvency appointment.

Heading towards insolvency? Some early warning signs.

In 2018-19 the top three nominated causes of failure for companies were:

Inadequate cash flow or high cash use (51% of reports)
Poor strategic management of business (43% of reports)
Poor financial control including lack of records (39% of reports)

Source: Australian Securities & Investments Commission

Early identification and intervention is the key for businesses to have ample opportunity to develop a robust plan to work through any such issues.

Stage 1 signs

Stage 2 signs

Stage 3 signs

Falling sales
Poor liquidity ratios (i.e. current, cash)
Poor management and financial accounting information – timeliness, accuracy, reliability
A realistic forecast cash flow shows a deficiency that can’t be met
A major client leaves or goes broke owing money
Fast moving product lines are often not in stock
Bank overdraft is constantly being pushed to the limit each month
Aged creditors are stretching and ‘blowing out’
Customers are consistently paying late
Directors not taking a salary
Repeated trading losses are occurring
Rapid sales growth is occurring without sufficient capital to finance it – “growing broke”
Failure of related company that is either owed money by the company or to the company
Refinance applications are being knocked back
Arrears or non-lodgement of BAS returns
Stress, marital problems or other factors impacting key personnel

Not paying superannuation
No genuine interest in buying the business
Being placed on stop supply/stop credit or cash on delivery
Repayment plans with creditors
Rent and other essential services unpaid or delayed
High turnover of key people
Large bad debt write-offs or provisioning
Disputes with auditors
Demands from uncontested creditors
Partial payments being made, i.e. instalments
Putting staff on forced holiday during an abnormal shutdown

Creditors removing stock under Retention of Title
Litigation or judgment debts
Wages being delayed
Receive eviction notice
Receive S222AOE Notice from the ATO
Receive Application to wind up

Are early indicators present? Here are some options

Recognising early indicators of financial distress is of limited benefit unless you are prepared proactively react. If you have identified that some of these early indicators are present in your business, there are a number of restructuring options to consider.

The current government amnesty means greater space to diagnose the business-critical issues while taking advantage of the various measures recently announced to support businesses through COVID-19. They allow business owners to address the pressure points with less immediate pressure to appoint an administrator or liquidator due to financial distress.

With the help of a suitably qualified advisor, you can determine if it is possible for you to:

continue to trade but scale down your operations
refocus your business back to its core operations and rationalise underperforming parts of your business
refinance the debt or raise further equity.

If all of these options are out of reach, you can choose to restructure your business through a voluntary administration process.

Early insolvency indicators do not mean your business is doomed. Proper advice and understanding your turnaround options as early as you can ensure you have every chance to set it right.

Insight New insolvency legislation changes give businesses breathin With the world now in the midst of a global pandemic, businesses are facing disruptions across all aspects of their operations and in the marketplace. These disruptions are challenging for everyone in different ways — but for some businesses, it means confronting a very stark reality: heading into the zone of insolvency for reasons outside their control. Read full article