Early Warning Signs of an Insolvent Business? We have picked 10 top signs of possible insolvency

"It is a truism that the earlier solvency difficulties are acted upon, the more likely a successful turnaround can be implemented. The longer such problems are allowed to fester, the more likely the condition will become terminal"

It is important for Directors to understand and be aware of the early warning signs of an insolvent Company, so that if some of these signs are identified, remedial action can be taken to avoid terminal insolvency, i.e. a winding up.

It is important to identify symptoms of problems in a client’s business and recommend corrective strategies.

It is a truism that the earlier solvency difficulties are acted upon, the more likely a successful turnaround can be implemented. The longer such problems are allowed to fester, the more likely the condition will become terminal.

Our top ten of warning signs of insolvency, is as follows:

1. Non-payment of Tax Liabilities

A Company will often forgo the payment of its tax liabilities to ensure that it has sufficient cash flow to meet its wages and critical supplier payments.

This may be considered by many to be an effective use of cash resources in the short term, however in the long term after those tax liabilities have continued to accrue penalties and interest are then imposed.

Companies should seek financial advice, as a restructure may be able to be effected and a repayment plan entered into with the ATO to avoid the issuing of any penalty notices.

2. Continuing Losses

Companies with continuing financial losses for the past 2 years should review the asset and liability position of the Company. Idle or non-performing assets may need to be sold, in order to purchase new assets that will generate income for the Company.

Financial advice in the form of an investigative accountants review could also be sought, in order to determine if there are any non-value adding processes in place that could be stopped and/or that a reduction in overhead costs and employee costs could be achieved.

3. No access to credit

In the event a Company has attempted to secure new lines of credit or to extend existing lines of credit, it may be necessary to engage an investigative accountant to consider alternative arrangements to be made, in terms of repayment of debts due, to achieve some breathing space and to free up some cash in order to continue trading.

4. Outside trading terms with creditors and supply on Cash on Delivery (“COD”)

When trading terms with creditors are well outside normal trading terms, i.e. 30 - 60 days and creditors are demanding that supply be made with COD, it is time to seek some financial advice in order to get trading back on track.

5. Receiving demands and/or other legal notices

When creditors are pressing for payment in the form of final notices and issuing legal demands, it will not be long before they receive a judgement order for their debt and proceed with winding up proceedings.

6. Sales are decreasing

If trading has been reducing over a period of time, it may mean a company needs to free up some cash to promote its product and/or service, or the company needs to diversify.

Financial advice should be sought to determine the company’s place within the market and identify its strengths, weaknesses, opportunities and threats and to develop a plan for the future. That plan for the future may be in the form of an orderly sale of the business and a wind down of the Company.

7. Unfunded superannuation

Businesses that have been utilising the funds earmarked for employee superannuation contributions, in order to continue trading, is not a good sign.

Superannuation payments are to be remitted quarterly and are required to be paid within the month after the end of each quarter. In the event the funds are not paid to the respective super funds within the specified timeframe these amounts  fall due as a debt due to the Australian Taxation Office, under the Superannuation Guarantee Act. In addition to the debt due, penalties and interest are applied.

These amounts may also be included in the penalty notice issued by the ATO and as such, Directors may find themselves personally liable for these debts as well.

8. Excessive reliance on related parties

Without any formal loan agreement and/or repayment plan, Companies may have been borrowing funds from related entities and/or family members.

In the event the Company is wound up, these debts will rank equally with all other unsecured creditors and if insufficient assets are realised, may not receive any dividend.

9. Low stock turnover

When a company’s stock is not moving and the majority of stock on hand is extremely old and in some cases, obsolete. This will affect the value of this asset that Companies have recorded in the balance sheet and after adjustment of the stock value, a negative balance sheet position may result.

Financial advice should be sought and perhaps an independent valuation undertaken, to assess the true value of the stock on hand.

10. High Accounts Receivable

The debtors of the Company may not be paying and the Company does not have an accurate figure on the total amounts owed or the collectability of those receivables.

A company may need to introduce a more effective debt collection process going forward.

Further, an increasing number of SME’s are utilising invoice discounting or other forms of cash flow financing to ensure continuity of cash flow and to streamline the debt collection function.

Conclusion

There is no hard and fast rule in determining the insolvent state of a Company and if any of these signs are appearing, financial advice should be sought.

Contact us for further information. We have the expertise to conduct investigative reviews of a company’s financial position and to prepare a solvency report on a company’s business.