Insolvency – is it for me?

There are a number of occasions during the life of a company in which it will face financial hardship to varying degrees of severity. Sometimes, during these positions of pressure it may be important to consider insolvency as an option.

Generally, a company is insolvent if it is unable to pay all its debts when they fall due. This is usually considered in reference to the actual circumstances of the company. This depends primarily on applying a cash flow test, which requires realistically assessing whether or not current cash flow and anticipated future cash flow is enough to sustain future liabilities to be paid when due.

One critical factor when dealing with potential insolvency is the looming question of insolvent trading, which can be punished as a criminal offence. Therefore, ASIC has released a regulatory guide with a number of points to consider the possibility of insolvency, which are as follows:

  • ongoing losses
  • poor cash flow
  • absence of a business plan
  • incomplete financial records or disorganised internal accounting procedures
  • lack of cash-flow forecasts and other budgets
  • increasing debt (liabilities greater than assets)
  • problems selling stock or collecting debts
  • unrecoverable loans to associated parties
  • creditors unpaid outside usual terms
  • solicitors’ letters, demands, summonses, judgments or warrants issued against your company
  • suppliers placing your company on cash-on-delivery (COD) terms
  • issuing post-dated cheques or dishonouring cheques
  • special arrangements with selected creditors
  • payments to creditors of rounded sums that are not reconcilable to specific invoices
  • overdraft limit reached or defaults on loan or interest payments
  • problems obtaining finance
  • change of bank, lender or increased monitoring/involvement by financier
  • inability to raise funds from shareholders
  • overdue taxes and superannuation liabilities
  • board disputes and director resignations, or loss of management personnel
  • increased level of complaints or queries raised with suppliers
  • an expectation that the ‘next’ big job/sale/contract will save the company

Should any of the above points ring true, there are a number of responsibilities that a company director has to ensure that the company does not incur debts during a period of insolvency. Similarly, ASIC has released a guide for directors to raise some key points of what to do when facing a similar situation.

  • Stay informed and monitor the company’s financial position
  • Be cautious of relying on third party financial and business advice
  • Investigate financial difficulties promptly and efficiently
  • Know when to seek advice from professionals

Professional member for the Australian Restructuring Insolvency and Turnaround Association (ARITA), Jonathan Paul McLeod, recommends seeking professional advice as soon as signs of financial hardship may appear. Furthermore, engaging in good business practice can help ever reaching that situation. For more information on insolvency and to determine whether you are trading insolvent, please contact us at McLeod and Partners today.