Avoiding Insolvency – 10 Warning Signs to Heed

According to the latest Australian Securties and Investments Commission data, the number of companies entering external administration in 2011-12 was at its highest level (10,757) since the Global Financial Crisis took hold in 2008 (10,005).

But when business owners and directors are in the eye of the storm, the warning signs of an impending crisis may not always be obvious.

William Buck Business Advisor Sean Wengel says there are a range of indicators of potential insolvency that, if identified early by an advisor or business management, can provide the opportunity to avoid business failure.

1. Poor Budgets, Cash Flow Forecasts and Business Plans

A businesses most basic need is a budget and associated information on which a director can make informed decisions.  It is not unusual for a business to have poor budgets or cash flow forecasts but a lack of these basic tools leaves business owners without simple information that can guide their decisions so as to trade profitably.

2. Delayed or Missed Tax Payments

In difficult times businesses will seek to improve short term cash flow by delaying payments that are not necessarily going to affect the ability to trade.  The most common type of payments that can be delayed are statutory taxes like PAYG and GST.

Non payment of taxes gives rise to a presumption of insolvency in the eye of the Corporations Act and directors can be held personally liable for insolvent trading.

Any business that delays tax payments or enters into repayment plans with the ATO for its ordinary tax obligations should be monitored closely for its ability to generate sufficient cash flows.

3. Delayed Employee Superannuation Contributions

As with non payment of taxes, superannuation contributions can also be delayed to improve short term cash flow.  As contributions are generally made every three months the employees and funds may not necessarily notice payments are delayed until they are well overdue.

Any indication the business is delaying or missing superannuation payments will raise serious concerns over its ability to continue to trade in the long term.  Unpaid superannuation can become a personal liability of the company’s director.

The Federal Government employee entitlements assistance scheme that advances unpaid entitlements to employees in the event of insolvency (GEERS) does not advance funds for superannuation.

4. Ageing of Creditors Increasing

Any increase in the time it takes to pay creditors may indicate the company is experiencing financial difficulty.  Particularly over time, if the ageing of creditors increases, the business may be experiencing difficulty in meeting normal payment terms.  Making on time payments to one creditor rather than another indicates the business has to prioritise its payments to satisfy the most essential suppliers first, with its limited funds available.

5. Poor Record Keeping

A business’ ability to maintain accurate and organised records is a good indication of its overall wellbeing.  A lack of financial records maintained in accordance with the Corporations Act gives rise to a statutory presumption of insolvency.

When a business is experiencing difficulty its management can tend to focus less on maintaining up to date records and this lack of currency can be a warning sign for impending failure.

6. Bounced Cheques and Dishonour Fees

A clear sign a business is struggling to make payments is bounced cheques and dishonoured payments.  Any business that experiences dishonoured payments is demonstrating its inability to make payments when due and will most likely not have the financial capacity to make payments within terms.

7. Bank Overdraft at the Limit

If a business regularly trades with its bank account at or near the overdraft limit its cash flow must be suffering.  The overdraft should not be regularly used in full as the business will have no immediate emergency funding if needed.

8. Tightened Supplier Credit Terms

When a business has a history of delayed payments to creditors some suppliers may place it on COD terms or reduce its trading terms.  Any change in the credit terms offered to a business would raise concerns over its ability to make payments on time.

Payment plans entered into with creditors are a common means to managing overdue accounts and can indicate the business is experiencing difficulty in paying debts when due.

9. Legal Action

Often the tipping point for a business’ failure is legal action taken against it resulting in some form of financial cost.  Any impending legal action should be monitored closely and the potential outcomes taken into consideration when forecasting cash flows.

Statements of claim issued against the business in relation to its outstanding accounts with suppliers are a major concern as they can easily give rise to involuntary liquidation.

10. Physical Aspects of Business

An inspection of the business’ premises will provide an indication as to its financial well being.  Often if a business is struggling its premises upkeep will be neglected.

The demeanour of staff will also provide indications as to the business’ overall health.  Employees are generally aware of the success or otherwise of the business and their conduct and mood will often deteriorate along with the business.

Recent loss of key management personell can often disrupt a sound business.  Any impending or unexpected departure should be managed carefully so as to avoid disruptions that will cause the business to take a step backwards.  Any backward movement will take much longer to recover from.

FOR MORE INFORMATION:

Bryony Vandepeear

Marketing Manager

William Buck

Ph: (02) 8263 4000

E: bryony.vandepeear@williambucknsw.com.au