Sometimes when I talk to clients about insolvency it is a bit like talking about death. They just don't want to do it or believe it.
Last month a client of mine was put into liquidation. The difficulties started about a year ago and I started to advise the company about 8 months ago. My discussions with the directors was always about cash flow and what we were going to do to keep the company afloat. We discussed insolvency and I was always conscious that we should not trade insolvently.
When one of the company’s major creditors suggested they would not support the company and wanted a large amount of cash upfront, my position changed and I advised the directors the company was insolvent. The next day the company went into liquidation. Once the company was put into liquidation the major creditor felt the business was not managed properly (it had) and that the directors had conducted business illegally (they had not). So much so that they managed to get the liquidator changed, even though the liquidator was actually chosen by me and independently from the directors.
These actions created doubt in my clients' mind and they asked for a letter of support from me confirming they had not traded insolvently which I duly provided.
The thing is, it got me thinking. Without specific advise how would a business owner know if they are trading insolvently? In most cases, they may not realise they are trading illegally. So I have come up with some warning signs that could mean the difference between breaking the law and being safe.
On average about 10,000 businesses go insolvent every year. So how do you stop being one of them? The answer might be below:
Losing sight of the numbers
I advise my clients to look at their figures at least monthly. When things are good, every business I know wants to look at their figures. But when things start to go bad, they give up and that really is a mistake. Every business should have a basic idea of their figures. When things are not rosy, the need for budgets and cash flow is really important. You really want to look at the figures when things are bad.
If the company goes into liquidation, providing this to the liquidator can show you tried your best and you made decisions based on actual facts or best estimates. The worst answer you can give a liquidator is that you had a gut feel or just felt things would improve.
Poor record keeping usually suggests poor business practices and will generally mean the business owner has no real idea of what is happening in the business. It then becomes easy for a liquidator to show you were trading insolvently and you cannot prove you were not.
Having a good qualified bookkeeper who knows the rules could mean the difference of keeping or losing your home and assets. Get a bookkeeper who is a least a tax agent. They have more knowledge and more experience.
Late or Non-payment of Taxes
This is almost always the case. The taxman usually always misses out when a company is put into liquidation.
Taxes are paid late because it does not affect the ability to trade. Not paying a supplier may mean they do not supply you. So it is easy not to pay the taxman. After all everyone hates the taxman, right? Under the Corporations Act, non-payment of tax can suggest insolvent trading. Many companies enter into payment plans and if entered into could suggest you considered your position and entered into a payment plan knowing that you intended to make all payments.
Non payment of superannuation/ PAYGW
This again, does not affect the ability to trade so is an easy one to withhold payment.
However, this is a very serious breach. Liquidators and the ATO view non-payment of superannuation & PAYGW seriously and as this can be recovered personally from the directors -- it can be a serious issue for you.
Non-payment to Trade Creditors or Creditor Days Increasing
Non-essential creditors start getting paid later and later. Constant calls from creditors and the position where you are paying Peter but robbing Paul in the process usually suggests the business is experiencing cash flow issues.
Preferential payments to creditors could also cause problems. When creditors are getting paid, they all need to be treated the same. Preference for some creditors over others can also cause issues should the business go into liquidation. The liquidator has the right to reclaim these back. Usually if a business has a bad history of paying creditors, it is not unusual for creditors to ask to be paid cash upfront or on delivery. This is a classic sign that the company may be trading on the edge.
Cheques are rarely used these days but if you find yourself promising but not paying, this could be a sign you are trading insolvently.
All Your Finance Facilities Are At Maximum
This usually means overdrafts and loans are at maximum and you cannot borrow any more. Even if you are not quite at the limit but are always ‘just under’ then this could suggest there are serious cash flow issues in the business.
Maximising credit cards also suggests cash flow is poor.
Current Legal or Impending Legal Action
If a creditor is looking to take action against you, this is a sure sign that you may be insolvent. This is usually the tipping point. If this, and the few items mentioned above are true, you really need to consider if the business is insolvent. Any action could lead to winding up applications.